Suntec REIT's 21 Harris Street buy could plug DPU dilution

The property’s long WALE and income guarantee for the first three years should cushion it from residential and economic downturns.

Suntec REIT’s latest Australian buy of a freehold Grade A office building in Sydney for $281.54m (A$297m) is forecasted to help close the 10-15% gap between the firm’s underlying operating distribution per unit (DPU) and headline DPU, which is currently supported by capital distributions, a report by DBS Equity Research revealed.

Located at 21 Harris Street, the site is being developed into a campus-style, nine-storey Grade A office building with ancillary café, childcare, gymnasium, basement carpark and end-of-trip facilities. The property has a net lettable area (NLA) of approximately 203,400 sqft comprising 181,900 sqft of office space and 21,500 sqft of retail space.

Also read: Suntec REIT buys Australian Grade A office for $281.54m

The property, which is the REIT’s second Australian acquisition, has an initial net property income (NPI) yield of 5.5%, and its weighted average lease expiry (WALE) by NLA is long at 10.2 years with in-built escalations of 3-4% per annum. The building is already 91.2% pre-committed and is anchored by Publicis Groupe, a global communications and marketing company. Publicis Groupe will use the property as its Sydney headquarters. Other key tenants in the building include Campfire (an international co-working operator), a childcare and gym operator.

By portfolio value, Australia’s contribution to Suntec REIT will increase from 11% to 14%. “We estimate minimal impact on underlying DPU, excluding capital distributions, post the acquisition of 21 Harris Street, after incorporating the drag from the additional 111 million shares issued from the recent $200m equity raising,” DBS analysts Mervin Song and Derek Tan said.

Near term, they expect marginally higher capital distributions to maintain DPU of approximately $0.10 per annum given the larger number of shares on issue.

“Nevertheless, given expected revaluation gains at the end of the year as Suntec’s properties are valued using more conservative cap rates versus recent market transactions, around $121m in cash and still some debt headroom remaining, we expect Suntec to complete additional acquisition/s this financial year to boost its underlying operating DPU,” Song and Tan highlighted.

This sentiment was echoed by a separate report by Jefferies, which noted that on a pro forma basis, the acquisition will be DPU accretive (around 50bps), and net asset value (NAV) dilutive (approximately 75bps).

In three years’ time, Song and Tan also forecast Suntec to have a clean yield without any capital distribution support. “This is possible as it benefits from higher office rents in Singapore, greater earnings from Suntec City Mall as the turnaround gains pace, and initial contributions from 9 Penang Road, 477 Collins Street and 21 Harris Street,” they noted.

Whilst some investors may be concerned about the increased exposure to Australia given the risk of an economic slowdown on the back of a downturn in the Australian residential market and increase in supply in the Central Business District (CBD) in 2020, Song and Tan noted that the risks may be mitigated by the property’s long WALE of 10.2 years, income guarantee for the first three years and in-built rental escalations.

Also read: Suntec REIT bullish amidst office rents upturn

“We understand that the income guarantee for the first three years is based on the rents paid by the tenants, such as Publicis Groupe (around 50% of the building) and Campfire (approximately 20%). The only ‘income top-up’ is based on 8.8% vacancy,” they noted.

Furthermore, vacancy at CBD Sydney is currently low at c.4.1% and, despite the new supply, is expected to tighten further given healthy net absorption, according to Knight Frank, which could translate into higher rents ahead.

The acquisition is expected to be completed in Q1 2020 when the property achieves practical completion. Suntec will reportedly make an initial $14.06m (A$14.85m) security deposit, with the remaining acquisition costs to be paid after practical completion. The firm should start receiving income from 21 Harris Street at end-Q1 2020 or early Q2 2020, Song and Tan said.