CapitaLand Ascendas REIT (A17U) Earnings Call Transcript & Summary

Thank you for joining us today for Ascendas REIT briefing on such a short notice. This is Wylyn from Investor Relations team. [Operator Instructions] Please be advised that this session is recorded. This morning, we announced the acquisition of 2 office properties in San Francisco in the United States as well as launched our equity fund rating to raise gross proceeds of approximately SGD 1.2 billion. Today, we have with us members of our management team to make a presentation and answer any questions you may have. From the managers team, we have Mr. William Tay, CEO; Mr. Lawden Tan, Head of Investment and Business Development; Ms. Koo Lee Sze, CFO; Ms. Yeow Kit Peng Head of Capital Markets and Investor Relations. From CapitaLand's U.S. team, we have Mr. [indiscernible], Managing Director; and Mr. Jason Bui, Head of Commercial. To start off, I would like to invite Kit Peng to make a presentation.

Morning, everyone. Good news. We have purchased 2 very good quality office properties in San Francisco, California, USA, for a total of SGD 768 million. Our discussion today will cover the following: details of the acquisition, key merits of property, pro forma financial impact, pro forma portfolio impact and concluding with the benefits to A-REIT and the unitholders. We are acquiring the 2 office properties for our combined proposed acquisition cost of about SGD 768 million. This is about 2.2% below valuation. Together, they will generate an NPI of SGD 37.6 million, and this translates into an NPI yield of about 4.9%. Both property fully leased to 2 tenants, Stripe and Pinterest, for a long WALE of 9.1 years. A standout feature is that the 2 properties are fairly new, they were built about 3 years old. In this section, we will elaborate on why these properties are a good [indiscernible] fit for Ascendas REIT. This acquisition announces the plan on foothold in San Francisco, one of the most dynamic and progressive cities in the U.S. The 2 properties are well-located in San Francisco, which is the epicenter of technology ecosystem and a leading life sciences cluster in the U.S. Some of you may remember that we made our maiden acquisition in U.S. last year. We acquired 28 business park properties in 3 cities, San Diego, Raleigh and Portland. So back then, we have said that these 3 cities are ranked in the top 10 tech cities in the U.S. So these tech cities tend to have high rental growth and are more resilient when compared to the general U.S. market because of the growing technology sector. So San Francisco is the second highest ranking tech city in the U.S. There is a continuous strong demand of space from companies in the tech sectors. Salesforce, Uber, Cisco, just to name a few, are some of the renowned companies that have established headquarters or regional offices there. It is attractive. This attractiveness is driven by the availability of high skill and educated workforce, high standards of living and excellent transportation infrastructure. San Francisco is one of the important centers for life sciences in the U.S. The potential for growth and demand for space is expected to grow stronger on the back of continuous investment from venture capitalists, et cetra. So -- to be more specific, both properties are situated in South of Market or in short SoMa. So SoMa is a leading submarket in the south of San Francisco. SoMa is well served by train and bus networks. The area has an abundance of amenities from restaurants, bars, museum, and also the location of the whole stadium of San Francisco Giant's, the city's baseball team. SoMa has the highest concentration of technology tenant. Renowned tenants in the area include Adobe, PayPal. It has consistently been ranked a top-performing submarket with an average occupancy rate of more than 96% of [indiscernible] properties since 2013. Average rental rate has grown 4.9% a year since 2013. So as mentioned, these are just -- you can see from here the slides on rental growth and occupancy rates. Future new office supply in San Francisco will also be limited because of Proposition E. So the Proposition E is about limiting new office development if affordable housing starts fall short. According to CBRE forecast, this new restriction will prevent nearly all new office development projects from being approved until after 2030. So what we know is that there will be these 3 office construction in SoMa currently. Both properties are newly completed in 2017. They feature large floor plates state-of-the-art building and smart building solutions for greater efficiencies. So who are our tenants? So Stripe occupies one of the building, 510 Townsend Street. And the other building 505 Brannan Street is occupied by Pinterest. Stripe is a private global technology company that builds and licenses online payment infrastructure. Their customers include Salesforce, Amazon, Google, Shopify, just to name of a few. Stripe's lease term is for 7 years. Pinterest is a social media sharing site. They are using this property 505 Brannan Street as their headquarters. Their lease term is longer at 12.4 years. On the leases, there are no termination options. So the WALE, as mentioned earlier, the average is 9.1 years. Both leases have escalation of 2% to 3% per annum. Rental collections so far are 100% to date. As far as COVID-19 impact is concerned, there is no rent relief given, neither have they asked for any form of assistance. So as you can see, the basic ingredients for these acquisitions are all very good. The total acquisition costs are SGD 784.3 million. We will be 50% funded by an equity fund raising to date, which we just launched and the remaining 50% by loan facilities. These 2 properties were added by SGD 0.129 or 0.85% to DPU on a pro forma basis. We expect an NPI of 4.9% pre-transaction cost and 4.8% post transaction cost. Portfolio impact, the additional SGD 784.3 million investment into U.S. will push our AUM to be up beyond SGD 13 billion of at SGD 13.73 billion to be more exact. A-REIT's overseas market exposure will be about 34%. And Singapore accounting for the remaining 66% of the event. This is in line with our strategy to remain Singapore-centric with overseas assets in developed markets accounting for about the 30%, 40% of portfolio value over time, as we have always done that. This entry into San Francisco will further strengthen our investments in U.S. technology cities. U.S. portfolio occupancy rate increases to 92.1%. Freehold exposure increases from 30% to 34%. After the acquisition, our top 10 tenants will be, you can see on the lower chart, SingTel, DSO, Stripe, DBS, CareFusion, Wesfarmers, Pinterest, Citibank, JPMorgan and Siemens. Within the U.S. portfolio, the proportion of tenants in the more resilient ICT, biomedical and digital media sectors will also grow from 65% to 75%. To conclude, we are really pleased with this acquisition. And strategic location and strong tenant base will allow us to tap into the growing technology sector. They are DPU accretive, and we know that they will contribute positively and augment the sustainability of A-REIT's earnings. Thank you.

Thank you, Kit Peng. Before we proceed with our Q&A session, I would like to invite our CEO, William, to say a few words. William?

Thanks, Wylyn. We are very pleased with this acquisition, and we are very pleased that this actually will strengthen the entire portfolio of A-REIT as well as our U.S. portfolio. If I can bring you back to what I mentioned in the past with regards to our strategy, is investing into merchant market, top-tier cities and as well as the asset classes that supports the driver of the economy. And when we went to U.S. last year, I mentioned that we are focusing on tech cities, which Kit Peng mentioned the top 10 cities, and we went in with acquisitions in Raleigh, San Diego and Portland. Now we have actually gone into the Tier 1 city, San Francisco. We were [Audio Gap] covenant and very good location. This is what we want to ensure that the resilience of the U.S. portfolio in relation to U.S. technology growth is within the portfolio. We also wanted to make sure that the strength of this tenants also improved the mix in our top 10 tenants, as you have seen, you see the top 10 tenants has actually very diversified talent base from technology, data centers, financial as well as logistics companies. This actually creates a larger base and provide better diversification across markets and across asset classes and across industry. So these are the few points I just wanted to make sure that you have that. And I'll prepare to take your questions. Wylyn?

Thank you, William. [Operator Instructions] Okay. We'll start off with Mervin from JPMorgan.

Congrats on the transaction. I think most of the proceeds seems to be being used for the data center acquisition. Just wondering if you can give us some details, the expected accretion, assuming all 3 acquisitions.

Interesting. Your first question is about the data center and about the 2 U.S. acquisitions. As we have [ mentioned ] the entire acquisition comprises -- target acquisition comprises of the data center portfolio in Europe as well as the suburban office in Australia. And we are actually doing a preemptive fundraising to ensure that the funds will be available when we do sign these transactions. So together with these 2 buildings in U.S., the DPU accretion is about 2% to 2.5% as a portfolio of the -- the 3 portfolio added together. We will make the necessary announcement to each of these acquisitions when we actually finalize and sign the agreements. Mervin?

Yes. Maybe a second question before I hand over to other people. But back on the U.S., I saw in the footnotes that for the Stripe building, they're looking to sublease space. And I think looking at property consultant reports, some weakness in rents. Maybe you can talk through how you're mitigating that risk on the process for the San Francisco market going forward? Yes. And work from home impact.

Thanks. This has always been top of mind with regards to acquisition in U.S., especially in San Francisco. The Stripe building, yes, they have made an announcement to sublease this building. But I'd like to draw your attention that the lease on hand is 7 years. And there is no termination or break clause inside the lease. We have a very substantial security deposit from Stripe as well as any subleasing requires the approval of the landlord as well as sharing of 50% of the profit rent. You mentioned about the weakness in rent. Year-to-date, probably came down about a few percent, which in certain locations, up to 6%, but considering the underlying contractor rent to market is still under-rented situation. With the 2 building, the under rented is between 5% to 20%. And we feel very comfortable that if they were to be able to sublease, there could be an upside as in sharing of our profit rent. But bearing in mind that the growth of technology has always been very strong. And we all know that technology sectors, technologies companies, they actually, most of the time, over lease the space that they require in order to provide for space in the future because their growth is so fast. And this is not new, and this is not unique to just San Francisco. It's also in Singapore. And we also feel that this is just short-term challenges that the Stripe may have, but they have 7 years' lease, unbreakable, and they will stay. In the terms of situation right now, they have given us 100% rented collection, no request for rent relief. So these are actually mitigations that we have for this market.

William, if I may add from the U.S. If I may add. This is [indiscernible]. We have known for a long time and the market has known for a long time that Stripe is moving to Oyster point, where they are building a larger facility, not so far away from SoMa. So part of their motivation is to grow in larger headquarters. The second reason why they are leaving is there's some tax motivation for the company, where they can save on taxes by going further south. On our side, I would add 2 more points. The Stripe building was designed with large floor plates and large load-bearing capability and high ceiling, which makes it very well-designed for both office and life science uses. And since we're right next to the Mission Bay Area, which is a very large life science concentration, we can tap both the tech sector market and the life science sector market. And then finally, I would add that pre-pandemic, the rent at Stripe is about 20% below market. So even though there's been some softness post pandemic, there is recovery, and we think that there's still a meaningful spread between what the property can lease for today versus what Stripe is paying. Therefore, there is a possibility for us to profit by taking half of the difference should Stripe be successful in leasing up its space. In any case, they are on the hook for a 7-year lease, as William mentioned. Thank you, William.

Next, I have joy.

Congrats. And my question, first of all, on office. You mentioned about sort of moving up the chain to strengthen your U.S. exposure by buying the 2 office building. Is this a broader strategy across your geography? Are we likely to see you explore office building in other locations that are led to tech tenants? Maybe we'll just start with the first question first.

Thanks, Joy. As I mentioned earlier, we will invest into the asset classes that supports the economy of the country. So I've mentioned last time, in the sense of business park or tech offices is quite clearly is a group engine in U.S., which is why when we step into U.S., the first acquisition was in tech offices. When we set into U.K., the first acquisition was logistics given that logistics actually supports the growth of e-commerce in U.K. If you ask about suburban office, tech offices, if you have seen in Australia and which is also the tech target acquisition that we had, is also in the suburban location. And this actually comes back to investing to asset classes that supports the driver of the economy. So if you include business park or campus offices in U.K., this is also targeted asset classes that we will look at, as we explore further opportunities in U.K. or Europe. Joy?

And maybe just a follow-on and just on the wider -- the bigger portfolio. Can we get an indicative size of the bigger portfolio that includes data center in the Australian assets? What will be sort of post-acquisition gearing you're looking target at?

Okay. The total size that we are seeing in our EFR is [Audio Gap] SGD 2 billion in total for the 3 acquisitions. Maybe Kit Peng want to address the gearing?

Well, okay. The equity fund raising today targeting SGD 1.2 billion, right, of equity, basically should help us maintain our gearing at a healthy level of about -- around the 37%, 38% level and maintain our Moody's A3 credit rating.

Okay. If I can just squeeze 1 last question on data center in Europe. Can I assume this is a sort of core and shell portfolio and any indicative?

The data center portfolio includes core and shell triple net leases as well as turnkey portfolio. This is across Tier 1 cities in Europe. So a common team, Joy, across the 3 acquisitions, they are all in Tier 1 cities, which we are very, very glad to be able to have this opportunity to scale up the data center acquisition. I would say that in Europe, the Tier 1 cities you would know, for data center are the flat market, which majority of the assets are in this location. And also, the other point that I wanted to raise about the entry into data center in Europe and as I've mentioned before, typically, when we look at acquisition and acquiring in each of these markets, we want to gain a foothold that's meaningful as the first entry. And this entry gives us scale to enter into the Europe data center market. And from then on, we actually can actually scale up and make it more meaningful. That is for the data center. For cap rates and other metrics, we will make note when we announce the acquisition.

Next, we have Mike from UBS.

I've got a question on the U.S. assets. There are also reports that Pinterest is looking to relocate its headquarters from the building into a yet-to-be developed building. So can you just comment on that, whether it's still ongoing?

To our knowledge, they have not -- they have actually reversed that decision. In fact, the deposit was actually forfeited, and they will stay in this current building, [indiscernible] or Jason, anything else to add?

Yes. So Michael, pre-pandemic, Pinterest had planned to develop an additional building in SoMa with Alexandria real estate, but it has since decided to put that project on hold. In fact, it's publicly known that they have paid $89 million to terminate that transaction and as a result, we'll be committing to this building of ours as their headquarters with a 12-year lease remaining. They have 3 other buildings in SoMa, and we believe that given their business model, which is both a creative technology and also a business in the sense that they rely on advertising, we believe that given that business model, they will be committed to be in an urban environment like San Francisco and SoMa in order to access the right counterparties and the right talent base.

Michael, just to add the [Audio Gap] newest building. The other building that is of substantial size, the expiry is 2022. So as Dong mentioned, they are in the other 3 building, but this is the longest lease, and we believe that they will continue to stay here, given that they have [indiscernible].

And maybe I'll just take the opportunity to say also that this building that we're buying, comes with a potential additional buildable area of 125,000 square feet or about 11,600 square meters. And so we have the opportunity at some point in the future, potentially, to expand the building for pinches, should they decide to expand in place. And so -- and by the way, we did not value that additional FAI in paying for the property.

That's good. Can I just follow up with the rationale for Alexandria and TMG to sell these assets?

I believe they do want to redeploy capital to some other development projects that we have in the portfolio. So this is what we understand.

Yes, I think it's been publicly announced that Alexandria is expanding throughout the country. So for example, Alexandria just purchased a $600 million portfolio in Raleigh, which is the third largest life science concentration in the U.S. after Boston, San Francisco, the third being Raleigh. And so we don't know for sure, but we think that this capital is being redeployed into new development projects and also to pay down their debt. I think all this is publicly announced by Alexandria.

Next, we have Brandon from Citi.

Just a question on this the reason for buying this portfolio and not the sponsors, business parks in Singapore? That's my first question, yes.

This acquisition in U.S. also came through a process. We were working on this for a few months, and we're very happy to make an announcement here and for the U.S. counterparts, with my team there. We definitely hope to close this before Thanksgiving. In regards to your question about Singapore's coming first, I think I mentioned, it's actually a continuous conversation with the sponsor. And since there is opportunities out there, that's in the rest of the market, we view that this is very accretive. And this actually helps to strengthen the portfolio of A-REIT. And now we have decided to push ahead with the acquisition of this few acquisitions that we have listed. So this -- I mean, 2 things, they are all separate. We feel that this is good opportunities and then we gently push on it. Brandon?

Okay. Another follow-up is that, I think with regards to what Joy asked as well, can you give us like a rough target mix between industrial and suburban office, maybe over the next few years as A-REIT looks to extend?

Suburban office and industrial, so long as it forms the entire asset clusters that supports the driver of the economy, I think we do not have a target allocation or a mix. But if you looked at how the world has moved, if you looked at how business parks, if, for example, they are in life science, they're actually supporting very much R&D as well as life science pharmaceutical users. In relation to other industrial, as I mentioned before, the key target that we are very keen on high-tech buildings, which then includes data center and high-tech buildings, meaning that it's actually with very good high specs, and we have seen that we have actually redeveloped 25, 27 from a light industrial into high-tech buildings. So this is also to prepare us for the industrial 4.0 as well as the new economy. In terms of mix, I would say that this actually will form bulk of our portfolio currently as well as in the future.

Next, we have Derek from DBS.

I just have a follow-up question on what you have mentioned. The property in the U.S. is 5% to 20% below market. Did I hear it correctly? Yes, and which building is 20% below market. I'm just curious because I think you need to sublease the Stripe property, right? So just wondering whether if you, let's say, mark-to-market, the whole portfolio, what would be the EOB?

Okay. Yes. Perhaps I can take that. So the larger discount would be for the Stripe building. But if we were to blend it, have a weighted average discount, it would be about 15%, right? And based on that and based on what we think achievable rent in this climate could be, then NPI yield potentially could be 5% or 4%. Yes. So yes -- so there's upside to our current NPI yield of that 4.9% that we have indicated. So if you mark-to-market, you'll be closer to the 6%.

Oh, wow. Okay. Sounds great. Just a follow-up question on that. I think there'll be really a lot of reports on how San Francisco is a very expensive city, right? So a lot of tech firms are going to [indiscernible] Austin taxes, for example. And for you to getting it back into San Francisco, seems to be a little bit countercyclical to what a lot of people are saying, maybe, William your thoughts on if you compare between these 2 broad strategies, right? Which one do you think is a longer runway?

I think we are very keen on both actually, even in the East Coast. We gained foothold now in the San Francisco. Primary reason is that the ecosystem is very strong for the tech as well as the life sciences industry. And if you look at the market there, vacancy has always been low. Rent growth in the past 5 years is capable of 5%, clearly demonstrated in our 2 acquisitions, they are under-rented. Primary reason is because they were pre-leased before the completion of the buildings, and the market has moved on to a different level. Despite COVID, the weakness in rental is only a small, less than 5%. And San Francisco is a market that we cannot ignore. We've worked from home. That's one challenge. We're moving to second-tier cities or triple location, that is also another challenge that the companies will face. And we also have mentioned before, we write on both where there's a growth and where there is also competitive rents for each of these tenants, I think the companies will then relook at how the real estate strategy for each of their company will make sense to them. So they may continue to have hub and spoke, having a HQ in a very good location, and you can check on their ecosystem with the VCs and the other peers in the country in a single location as well as tapping to the talent pool in second-tier cities, like in the East Coast at Raleigh that we have. And each of these cities are all backed by very strong universities, which produces the talent. And these are markets that we cannot ignore with regards to the current challenges of working from home or moving to second-tier cities. Dong, anything to add?

Yes. I think I would say that we have a dual strategy, Derek, focusing on ecosystems like San Francisco, which, in our view, are just irreplaceable. There's no question that the tech tenants are moving some of their less core functions outside of San Francisco to cut costs, but we think that San Francisco will always be a mainstay because of the founder community, the venture capital community, the other counterparties, the other companies in their ecosystems as well as, of course, research and talent pool from Stanford, Berkeley and the University of California at san Francisco, which is known for life science. So our strategy is an and strategy. So San Francisco and other markets like Raleigh, like San Diego, locations like perhaps Austin, where tech companies go to. The other comment I would make is that San Francisco is very geographically constrained. Therefore, not only do we have the strength of demand as the market recover from the pandemic, but also supply is very limited. In the more growth markets like even Raleigh, while demand is very good, you have to be in a very central location to have a defensible position. And so we like the -- we still like the San Francisco position very much. And really, the pandemic did give us an opportunity to buy this portfolio at a fair and attractive price.

Next we have Tan Xuan from CLSA.