Sunday, May 5, 2013

Croesus Retail Trust

This May, we will be seeing IPO of Asian Pay TV and Croesus Retail Trust (CRT). They are both business trust (not REITs), highly geared and most importantly offering a 8% yield. Where else on SGX can you find a 8% dividend yield? The question should then be why are they not pricing at lower dividend yield and hence leaving money on the table?

Total unit is 430,178,000, NAV is $378,337,000 or $0.88. The IPO price is trading 1.05x NAV.
CRT is made up of 4 main assets situated in Japan worth 57 billion yen. As seen from the table below, other than Luz Shinsaibashi, they are mostly located in small cities with population of 200,000 and below.

Figure 1 - Classification of Cities for Asset

Lease Structure

Figure 2 - Breakdown of NPI in 2014

The figure above shows the contribution of the 4 assets, where Mallage Shobu contributes the largest proportion of Net Property Income (NPI).

Aeon Town Suzuka and Moriya
Aeon Town Suzuka and Moriya are master-leased to Aeon Town, a subsidiary of Aeon Group, that catered towards neighbourhood shopping centre (NSC) as compared to Aeon Mall which specialises in higher end shopping centre. In a master lease, the owner of the property will lease it usually to 1 master leasee who will be put in charge of the sublease and running of the mall. The NPI margin will be much higher as most of the operation expense is bore by the master leasee which gives CRT a 90% NPI margin for its 2 master leased mall.

The master-lease is signed for a long period of 20 years from 2007 to 2027. Unlike most master lease we see in S-REITs, there is no step-up rental which means that the total rental revenue to be earned by CRT is FIXED for the next 20 years - 932 million Yen and 660 million Yen respectively. The good thing about master lease is that unit holder has a great certainty about what they are likely to get and will get. However, with no step up rental, the real yield after accounting for inflation (in Singapore) will get lesser and lesser. This is not unexpected as Japan has been in a deflationary environment for decade and hence no step up has been in place to account for possible inflation. In comparison, most leases in Singapore will take into account inflation, introducing step-up and positive rental reversion each year.

The only potential for growth for these 2 assets which account for 45% of total NPI will be a restructure of the lease, converting it from master lease to individual lease with the tenant. However, this option don't look much more attractive as Mallage Shobu (not a master lease) only has a NPI margin of 50% as compared to the 90% that these 2 assets enjoy. Such a conversion is not likely to bring in much positive as the margin will be lower and there will be an added risk of re-branding the mall and ensuring full occupancy.

In addition, the master lease has been structured such that from 2016 and 2017 onwards, contracts will be renewed every 2 years subject to agreement between both parties. Thus, there exists a risk that Aeon Town might not want to master lease the mall, leaving CRT in a lurch. Though this risk is remote as Aeon Group is the 2nd largest Japanese retailer by sale which makes them a strong counter-party, it is still something that unit holder should be aware of.

Luz Shinsaibashi
This is their prime asset in Osaka, though it accounts for only 14.4% of NPI. H&M is the major tenant here accounting for 58.4% of the space with the rest of the space occupied by 2 restaurant and 1 karaoke lounge. Once again, H&M has signed a long term lease that will only expire after 2024 and they accounts for 85% of the asset's total rental income. The 4 tenants have a lease term of 7-15 years which is very long lease term as compared to the standard 2-3 years in Singapore retail. While 2 leases are on variable rent, it is stated in the prospectus that "the Trustee-Manager expects that the turnover threshold which trigger variable rent will not be met."  Once again, growth is not to be expected. The earliest expiry of rental will be in 2017, where 1 leasee that accounts for 5.6% of the rental income of the asset will be up for renewal. This leaves us with only 1 asset - Mallage Shobu which accounts for the largest proportion of NPI.

Mallage Shobu
This is their only asset with the potential to grow the NPI as they are generally variable rental and not a master lease structure. They have 7 anchor tenant with lease term of 6-20 years and account for 1/3 of Net Lettable Area. The rest of the lease are variable rental and the contract term is typically 6 years. According to the prospectus, 151 out of 243 fix term leases are up for renewal in November 2014 and significant rental reversion is expected given the low rent signed during 2008.

These rental will account for 26% of gross rental income of CRT which works out to be 1.3 billion yen. From the prospectus, NPI in 2014 from Mallage will increase by 13% from 1.26 billion yen to 1.43 billion yen. Overall, the NPI will increase by 5% for CRT and the net impact to dividend yield will be that it will increase from 8.0% to 8.1%. Thus, their only hope for growth is not going to be of much impact in 2015. After 2015, the lease term will be on market rate and hence not likely to see much positive rental reversion. Given it is another 6 years before lease renew in 2021, this one-off reversion is not going to happen soon.

Examining Mallage Shobu, it is located in a mid-sized city called Kuki-Shi in Saitama. It is 7km from Kuki Station and 10km from Kitamoto Station which is really far away. The figure below is the age profile of those staying 5km within the mall. 44.5% of the population is older than 50 years and this is the highest among the location of its 4 malls and is higher than the national average. Population is stagnant and large-scale retail sales for Saitama has dropped almost every single year since 1998 other than in 2002 and 2005-2007. Thus, the variable rent structure is not going to be of much help.
Figure 3 - Age Profile within 5km of Mallage Shobu

Figure 4 - Large-Scale Retail Store Sales for Saitama

Macro Retail Trend
Figure 5 - Total Retail Sales

Figure 6 - Average Retail Floor Space

As seen from figure 5, the total retail sales of Japan since 2001 has been flat. Shopping Centre Sales only grown from 19.5% to 20.5% of total retail sales which is insignificant growth considering a 12 years period. However, from figure 6 the dark green line, retail floor space has grown and is on a upward trend. Thus the annual sales per sqm has dropped since 1991. This is obviously not a good sign for any shopping mall owners. The key to positive rental reversion is growth in sales of the tenant. Only when your tenant is making more money, will you be able to increase your rental as no tenants will enjoy a lower profit margin. This is perhaps why malls in Japan are generally master-lease or of long-term lease structure unlike in Singapore.

Figure 7 - Large-Scale Retail Store Sales for the perfecture of its 4 malls

Figure 7 is large-scale retail store sales for the perfecture of its 4 malls. As we can see for the past 15 years, they are all on a downward trend else flat. Ibaraki has done the best by staying flat while Osaka has seen sales dropping by 25%.
Figure 8 - Historical Shopping Centre Rents

Looking at the historical rental, they have also stayed flat just like the total retail sales. The perfecture which CRT's malls are located are Osaka (Orange), Saitama (Light Red), Ibaraki (Light Blue) and Mie (Purple). On the macro level, there really don't seemed to be much of a growth unless Abenomics is successful.

Before people starts to jump into CRT for its 8% dividend yield, maybe the leverage should be considered. Leverage plays an important role in determining the dividend yield of a REIT. Assuming an unleveraged REIT with an Return on Asset of 3%, a unit holder who purchases the REIT at NAV will get a 3% dividend yield. This is obviously unattractive considering that some blue chips can yield 4-5%. Thus, REIT will often borrow more money to buy more asset, so that the dividend yield will be higher. By borrowing 30 cents on $1 of equity, the yield of the REIT will now be 3% x 1.3= 3.9%. This is why almost every single reit is borrowing near the 35% gearing ratio as allowed by MAS for those that do not get rated by a credit rating agency.

In the case of CRT, the gearing ratio (calculated by debt/value of property) is 48% whereas most S-Reit stays within 30-35% after learning their lesson in the GFC 2008. Thus, how can it be fair to compare the levered 8% dividend yield to a less levered yield reit? If we were to compare CRT with a S-REIT with a 30% gearing ratio, the 30% levered dividend yield will be 8% /(100/52) * (100/70) = 5.94%! What a big difference the high gearing can bring about. Leverage is always attractive and I am sure many folks are more than willing to dismiss it.

Given the high gearing, it is imperative that we look at the way the debt has been structured. Leverage is particularly dangerous for REIT/ business trust given that most practices 100% payout ratio on distributable income. Thus, when the time comes to pay the loan, they will refinance it as they have no mean to pay it back since they do not retain cash.

What struck me when I look at their debt is that they are only funded by 2 sources of debt - S$299.8m in loan and S$31.9 million in bond. Both debts are provided by only 1 bank, Mizuho Corporate Bank, and the tenor will be 5 years with an additional 2-year Tail period. The interest rate will be Base Rate + 0.5 % (0.75% for bond). The problem I have is that it is very dangerous to borrow from only 1 bank with the same repayment date when they need to re-finance their debt. If CRT just happen to have to refinance their debt during a crisis, bank will tighten their lending activity and CRT will find that it may not be able to borrow the same sum of money again. The result will be either to sell off your asset or to do a much dreaded cash call. A good reit/ business trust manager will not only diversify the source of funding but also spread the repayment date over several years.

For the issue of debt covenant, there do have quite a bit of buffer.2 main covenants will be to maintain a minimum stressed debt service coverage ratio of 1.3, calculated based on NPI dividend by 6.6% of debt and not to exceed the maximum loan-to-value ratio of 60%. Current debt service coverage ratio is 1.88 while LTV is 48%. NPI will have to drop by 30% which is unlikely given the master lease structure and value of property needs to drop by 20%.

Lastly, I find that the interest rate of 1.7% paid by CRT seemed a bit too low and is more than likely to rise in the future. If interest rate were to rise by another 1%, it will incur additional interest expense of 2.5 billion yen which will reduce the distributable income and hence dividend by 10%.

Corporate Structure
Why is CRT not offering it in Japan where the Japan Reit Index has an average dividend yield of 3-4%? In Japan, there is not limit on the gearing ratio and they will also be able to enjoy tax transparency. One possible reason could be that their asset size of 57 billion yen will make them the third smallest reit among the 40 listed in Japan. There was a wave of merger and consolidation since 2008 such that number of J-Reit has dropped from 42 in 2008 to 36 in 2010. Currently, there are 39 J-Reits that are listed after 2 new listing in 2013.

So why are they listed as a business trust and not as a REIT? Most J-REITs are highly geared as they do not have any limit on gearing ratio. CRT is highly geared and will have to get a credit rating agency to rate their credit standing if they want to be listed as a REIT. Since they do not want to be rated, it is better off for them to list as a business trust. Neither will they be required to distribute 90% of their profit to be exempted from paying corporate tax.

Fee Structure
I find the fees earned by the asset manager much higher than the almost all S-REIT. The base fee charged is 0.6% of the value of property and 3% of NPI. The common fee charged is 0.3% of value of property and 3% of NPI. I believe this is one of the highest management fees being charged.

Secondly, I find that the property management fee for Mallage Shobu is incredibly high at 9.5% of gross rental income and 30% of amount of net operating income in excess of an unspecified agreed figure. In comparison, ARA only earns 3% of gross rental income for managing Suntec Convention Centre. It seemed like Sojitz is getting a much better deal than unit holder. The reason given below seemed unconvincing.

"However, the Trustee-Manager believes that the incentive fee payable to the property manager of Mallage Shobu is commercially fair and reasonable for the reasons stated below.

Mallage Shobu faces competition from Viva Mall and Ario Washinomiya (newly opened in November 2012), both located within a 5km radius from the Property.
In addition, the property manager has been managing Mallage Shobu since November 2008 (being the opening of the retail mall) and is therefore well placed to continue with the management of Mallage Shobu given its knowledge and experience with Mallage Shobu. In the context of the competitive operating
environment, the experience of the property manager and the substantial level of operating and management effort required in respect of the large number of sub-tenants, the Trustee-Manager believes that such
incentive fee is commercially fair and reasonable to incentivise the property manager towards realising revenue growth for Mallage Shobu and achieving performances that are challenging to attain."

Other Risks
No Insurance Against Earthquake - Earthquake insurance is expensive in Japan given that it is a common phenomenon. Earthquake insurance will be taken up only "where the Probable Maximum Loss for a Property is in excess of 15% of current building replacement construction cost. Probable Maximum Loss is
defined as the probable maximum loss (i.e. repair and reprocurement expenses) that would be
incurred if a major earthquake struck. Specifically, it means the loss generated by the largest
earthquake that has a 10% probability of occurring during a 50 year assumed service life of a
building." The probable maximum loss for the 4 shopping centres are 1%,5.5%, 7.2% and 2.1%. I always have my doubt about such statistics and we should never forget about Taleb distribution.

Currency Risk - Currency risk is another real risk that we face.Successful Abenomics will cause Yen to depreciate whereas MAS is likely to continue letting SGD appreciate. Dividend translated will then be lesser by the amount of which Yen depreciate. Currency risk is a real risk that anybody should be prepared for. Just look at how much USD and GBP have depreciated against SGD.

One common counter-argument will be that if Japan succeeds in its monetary policy, inflation will resume and hence rental will go up which will counter-act the depreciation in Yen. However, the rental structure of CRT is long term such that the shortest lease is usually 6 years. It will take time to renew the rental at the market rate should the market rate goes up. Many leases expire beyond 2020 as many simply do not expect any inflation given the 20 years history.

While 8% yield is high, lets not forget that high yield usually comes with higher risk. The 8% yield is achieved as a result of its much higher gearing ratio. Unlike many S-REITs where we can expect organic growth coming from step-up or positive rental reversion, there is not going to be any significant growth for the years to come. It will also be hard to conduct any AEI as 3/4 leases are long term leases where it is unlikely that the leasee has the incentive to conduct AEI. Neither should we expect too much from Abenomics as there are certainly much better play out there on Japan's depreciating currency and inflation than CRT.

The debt seemed dangerously structured and lets hope that 2018-2020 will be recession-free else they will be having trouble refinancing their debt. All unit holders should also be prepared for a cash call given the high gearing. Any acquisition is going to come from the pocket of unit holder.

Inevitably, I am sure that this will be oversubscribed because there will be chase for yield and those that are going for a stag in expectation of those chasing the yield. Will be interesting to see what kind of yield and price it fetches when trading begins. Doing a simple Dividend Discount Model shows that at $0.93 it is rather fairly valued.


  1. Hi

    I am sure the CRT will be oversubscribed as well. Just look at how people are buying up on Saizen Reit. Looks like Japan assets are back in favor now.

    1. The job of an investor is to look for undervalued asset and not to look for an asset where a greater fool will buy at a higher price. Perhaps, we can succeed a few times, but in the long run it is likely that we will suffer more loses.

  2. Hi, its being a looong wait since your last article. I am a big fan of your analysis, though I mayb twice your age, but I started to really learn abt investing less than a yr ago...

    Your articles really sped up my learning process, pls keep this article coming if time allows!


  3. Wow very Good and comprehensive, thanks for the article.
    I would like to share some of my views on that,
    personally I did not jump into it,
    because i felt the 1.15 close price is already overpriced for a REIT.
    IPO is 0.93 and it says 0.9 NAV so it is 3.33% premium p/nav, and 26% upside potential in 12 months meaning possible price 1.17 (first day high 1.18) in 12 month.
    1st day closed @1.15 (roughly) meaning upside of 23% which capture almost whole year upside potential.

    few things here, I'm surprised by it is Cost of debt 1.7% too. However, You may wanna consider the macro-econ which jap is printing non-stop so far hoping to achieve inflation, therefore to me, i felt that the cost of debt is likely to stay for sometime, or optimistically, lower in the future.

    They went for gearing and they hedge the return to secure the yield for the 1st 2 yrs. which i think it is the reason for the folks to jump in, BUT hedging is costly as well and only 2 years then they will maneuver around base on the situation, meaning they are taking quite high risk after that. (stock will fluctuate quite a lot)

    expecting many of the 11 corner stones to throw their state in 6 months later. the 1st day stock price already gave them more than 20% return. (what is the reason to keep for long, unless the REIT has a very bright future, in which i do not agree:you already describe quite thoroughly)

    However, so far I still not state what's the purpose of saying all these.
    To me, I'm more on value investing (long term), so I would like to see how long can this REIT go and whether or not the price is worth the money. So do you, i felt that after reading through the article, i cannot identify what kind of investor you are. So maybe you would like to stretch more on that like what kind of investor you are (e.g. short term basically less than a year or so, mid term 1-2year, or long term 1-30years etc) then your article would attract more people with the same interest as yours. I think they will greatly help you in the future as you are really young and already could be so thoughtful.

    I like the point of risks which you mentioned about inflation.
    Most People don't expect inflation in japan, but it is coming.

    Warm Regards

    1. Cost of debt will not be low just because of continuous money-printing. Using Fisher Equation -> Nominal Interest Rate = Real Interest Rate + Inflation Rate.

      With inflation, nominal interest rate will start to go up. The reason why cost of debt is so low is due to the deflationary environment that it has been in for decade. Thus, instead of lower interest rate, you will get higher interest rate with inflation. To put it another way, if the inflation rate is 2%, will bank want to lend money out at 1.5% to see their Real profit getting eroded? More people will also sell out of bond with inflation, bond price will drop and interest rate will rise.

      With Japan's interest rate at such low level, it seemed like the only way to go is higher and not lower, unless they go into negative interest rate.

      Personally, I am a long term investor who is willing to hold and wait for at least 3 years. Nonetheless, if value is realised much faster than my investment horizon, i will liquidate my investment.

    2. WoW prompt reply, Thanks.
      Yup, do agree with you. (Like i used "optimistically" which is unlikely to happen)

      I have just read some of your other posts, very thoughtful in research.
      I have bookmarked your blog and will pay more visits :P in the future.

      keep up the good work, and Wish you have a fruitful 2013.

      Warmest Regards,

  4. Your knowledge has far exceeded your age.

    Would you be interested to exchange link?
    My url is

  5. Good write-up, but before reading your article, I had a "stag" call on this stock which turned out to be the right recommendation.

    1. Given the mood at that point in time, it seemed a good stag. Then again, every bubble is as such until it bursts when everybody least expected.