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A Possible Danger to OUE Commercial REIT’s Yield That Investors Might Have Overlooked

OUE Commercial Real Estate Investment Trust (SGX: TS0U) is a new kid on the block as it just went public on 27 Jan 2014 at S$0.80 per unit. Since then, the REIT has traded within a tight band of its offering price and is currently right where it started, at S$0.80 per unit.

Back in Sep 2013, the real estate company OUE  (SGX: LJ3) was mulling over the spin-off of its office building, OUE Bayfront, into a REIT along with some other commercial  properties that were owned by Hong Kong-listed real estate outfit Lippo China Resources.

Those plans by Overseas Union Enterprises eventually came to fruition through OUE Commercial REIT, which now holds two properties under its belt – the aforementioned OUE Bayfront that’s located in Singapore, and the Lippo Plaza Property that’s situated in Shanghai, China.

In its listing-prospectus, OUE Commercial REIT had forecasted a distribution per unit of 5.44 cents and 5.51 cents for 2014 and 2015 respectively. At its listing price of S$0.80, that would give the REIT an estimated forward distribution yield of 6.8% in 2014 and 6.9% the following year.

For a REIT that deals with commercial properties, OUE Commercial REIT’s forecasted yields are mostly in-line with its peers in the commercial property space and much higher than the average dividend yield of around 2.9% for the Straits Times Index (SGX: ^STI).

REIT Price Distribution yield
CapitaCommercial Trust (SGX: C61U) S$1.40 5.8%
Keppel REIT (SGX: K71U) S$1.12 7.0%
Frasers Commercial Trust (SGX: ND8U) S$1.24 6.7%
Suntec REIT (SGX: T82U) S$1.62 5.8%
OUE Commercial Real Estate Investment Trust S$0.80 6.8%*
*Based on IPO forecast

Source: Various REITs’ latest earnings releases

So while the ostensibly high yields of OUE Commercial REIT might look attractive, it’s based on a very important caveat: the REIT can only achieve that yield based on income support. If income support’s removed, the REIT’s distributions for 2014 and 2015 would fall to 4.45 and 4.60 cents respectively, giving forward yields of 5.56% and 5.75%.

Income support can be understood as a party helping to make up any difference between the desired rental income a REIT wants, and the actual rental income a REIT’s getting. In OUE Commercial REIT’s case, OUE would be the party providing income support for the OUE Bayfront property for up to a total of S$50m over five years starting from Jan 2014.

If the quarterly gross rental income received by OUE Commercial REIT from OUE Bayfront falls below S$14.25m in any quarter over the next five years, payment from OUE –  which can go up to an annual limit of S$12m – would be triggered to make up the difference.

The table below showcases snippets of the REIT’s forecasted financials for 2014 and 2015 to once again highlight the importance of the income support to unit-holders’ distributions.

2014 2015
Income support S$9.63m S$8.92m
Distributions S$47.4m S$48.3m
% of distributions made up of income support 20% 18%

Source: OUE Commercial Real Estate Investment Trust’s Prospectus (page 131 and 132)

When the income support ends, it’s really up to the ability of the manager (a wholly-owned subsidiary of OUE) of OUE Commercial REIT to improve or maintain the gross rental income that OUE Bayfront can command. Given how the income support is making up one-fifth of the REIT’s forecasted distributions, it’s something investors should carefully consider.

All told, this serves to highlight the importance of combing through an IPO-prospectus to understand the important revenue and profit drivers of any share that an investor might be interested in.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.