Sasseur REIT is set to become Asia’s first outlet shopping mall REIT. It has a portfolio of four outlet malls in China, valued at approximately S$1.5 billion.
In my earlier articles (here, here and here), I took a look at some key aspects of the trust, including its balance sheet, projected rental income, property yield and the risk factors. Here are some further details about how the REIT achieves its rental income and the risks associated with that income.
Differs from traditional retail REITs
Traditional retail REITs receive rental income directly from the tenants. However, Sasseur REIT has instead decided to adopt a structure, in which it appoints an entrusted manager to manage their property and collect fees from the manager instead. This is similar to a master lease agreement more commonly seen in hospitality and health REITs.
The entrusted manager agreement
Sasseur Shanghai has been appointed as the entrusted manager (EM). In the entrusted manager agreement (EMA), Sasseur Shanghai is to maintain, manage and operate the assets in the REIT. Sasseur Shanghai has signed a 10-year contract with the REIT starting from the listing date. The entrusted manager agreement has two components, a fixed and variable component.
According to the prospectus, the fixed component has a built-in 3% annual escalation rate, while the variable element is pegged to each asset’s total sales. The fixed component gives the REIT a stable income while the variable part allows the REIT to partake in higher tenant sales.
Minimum rent agreement
According to the prospectus, the entrusted manager, Sasseur Shanghai, will also ensure that Sasseur REIT will receive a minimum rent of RMB472.9 million for 2018 and RMB611.4 million for 2019.
In other words, if the resultant rent, after taking into account the fixed component and the variable component of the EMA falls below the minimum rent, Sasseur REIT will be entitled to claim the shortfall from the entrusted manager. This provides Sasseur REIT with income support in case tenant sales do not meet expectations.
Highly dependent on tenant sales growth to meet minimum rent agreement
The prospectus also released the projected fixed component for 2018 to be RMB318.9 million, and variable component to come in at RMB 154 million. The prospectus did not release estimates for the breakdown in 2019.
However, based on the assumption that the fixed component will increase by 3% annually, we can calculate that the fixed component of the EMA will amount to RMB328.5 in 2019. This means that the variable component of the resultant rent will have to grow from RMB154 million in 2018 to RMB282.9 million in 2019 so that the rent meets the minimum rent agreed of RMB611.4 million for 2019. That translates to an 83.7% increase in the variable component of the EMA and will make up approximately 46.3% of the resultant rent.
Because of the projected larger contribution from the variable component in 2019, any hiccups in tenant sales growth will, therefore, have an impact on the manager achieving the minimum rental agreement.
Risks beyond the third year
The minimum rent agreement gives Sasseur REIT income support and protects it from downside risks. However, if the resultant rents exceed minimum rent for 2018 and 2019, the minimum rent clause of the agreement will fall away.
The risks of downturns in the retail market in 2020 and beyond would then be transferred from the entrusted manager to the REIT and its unitholders.
The Foolish bottom line
From what I can tell, the EMA does indeed have many advantages. First, the long-term contract with the entrusted manager and fixed component of the contract shields the REIT from any downside risks. The minimum rent clause provides additional income support for the first two years. Furthermore, the appointment of Sasseur Shanghai makes sense as they have experience managing outlet malls and have been managing the properties since their commencement.
However, one downside worth highlighting is the high EM fee that the REIT has to fork out. The base fee itself can be up to 30% of the gross revenue of the properties. On top of that, the EM will be paid additional performance fees based on gross revenue and resultant rent.
Investors will have to keep a close watch on the performance of the REIT in the years ahead before they can decide whether this model has succeeded in providing investors with a higher rate of return than the traditional direct leasing model.
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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 contributor Jeremy Chia doesn’t own shares in any companies mentioned.