aReit that I'll be avoiding

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aReit that I'll be avoiding

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Published Date: 2022-01-11 | Source: INCE|Community | Author: The Finance Ghost

aReit that I'll be avoiding

I got very excited when I saw an abridged prospectus come out for a new listing on the JSE. It's been one-way traffic in terms of delistings, so the news of the listing of aReit Prop Limited certainly caught my eye.

By the time I had finished reading the announcement, my excitement had died entirely. Trying to access the corporate website and being met with a WordPress theme that was still in build phase didn't do anything to improve my confidence. The colour of the logo even changed from purple earlier in the day to blue by the evening. For the sheer comedic value of sending out an abridged prospectus with a website that isn't finished, I used a screenshot as the feature image of this article to preserve this moment.

Before we delve into the specifics of aReit, let's take a brief look at property structures.

REIT stands for Real Estate Investment Trust, a legal and tax structure designed to encourage the listing of property investment funds that generate dependable and ideally growing dividends. This is great for retirees and people with a lower risk tolerance than the kind you need to be buying flashy tech companies.

It all worked well until the pandemic, when "low risk" property funds suddenly weren't such low risk overall. This was an unprecedented period for all of us, with property funds taking one of the hardest knocks.

REITs are priced based on a yield. For example, a large diversified REIT may trade on a yield of somewhere around 8%. If the portfolio can generate R80 million a year in net operating income, it would be worth around R1 billion. One would then deduct the debt to calculate the net asset value (NAV) and would expect the fund to trade at a discount to that NAV due to head office costs etc.

With that quick theoretical overview out the way, let's take a closer look at aReit.

aReit is aiming to offer 30 million shares at a price of between R8 and R10 per share, with a median target price of R9 per share. In other words, they expect to raise around R270 million. This is quite small for a JSE Main Board listing in the property space.

The company holds a "slightly diversified" portfolio (their words, not mine) of two hotels and a medical property. The abridged prospectus announcement also highlights that the company earns rental income from a billboard above the Cresta Grande Hotel, one of the hotels in the portfolio.

The billboard is only good for R960k per year in revenue. Far more important is the Cresta Grande Hotel itself (R18 million income), the Fountains Hotel (R13.2 million) and the Lady Hamilton medical property (R7.8 million).

The hotel leases provide for a base rental and a variable rental of 25% of turnover, whichever is higher. This gives the fund some upside potential if hospitality recovers, while providing the minimum rental amounts as indicated above.

There is no debt currently in the fund. It has been put together by the previous property owners selling their properties to the fund and being issued vendor shares. This simply means that they have pooled their assets to bring them to market.

With that information alone, my view would already be that this is an obscure listing with a portfolio that is unlikely to get asset managers excited at the most important institutions in the country. That's before we get to the valuation of the property portfolio, which is where my brain explodes.

The prospectus notes that the property portfolio has been valued at R913.9 million. With annual minimum rental income of R39.96 million, that's a yield of just 4.4%. There is the potential for it to be higher depending on how the hotels perform, but it needs to be vastly higher than that to be interesting.

The valuation report (which became available on the website later in the day) notes that a discounted cash flow approach was used. It doesn't seem to mention the discount rate used (the key variable in this method) unless I'm blind and missed it somewhere.

If the fund were to trade at the yields more commonly seen for a portfolio like this (10% - 12% as investors can be ruthless on small REITs), the value of the portfolio would be significantly lower than what has been put forward in the prospectus. That would be a financial disaster for anyone who invested in the IPO on a yield of 4.4%.

If you have a look at this listing and come to a different conclusion, then please reach out with your thoughts as I would love to hear them. Personally, this is aReit that I'll definitely be avoiding.

I'm also not sure what could've gone so wrong in the process for an abridged prospectus announcement to have gone out while the website was still under construction.





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