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3 Reasons I Will Not invest in ESR-REIT

Previously known as Cambridge Industrial Trust, ESR-REIT (SGX: J91U) is the sixth largest industrial REIT in Singapore’s stock market. It has a portfolio of 48 industrial properties located around Singapore. Its properties, which are collectively valued at S$1.68 billion, include general industrial buildings, light industrial buildings, logistics facilities, hi-specs industrial space, and business parks.

2017 was a challenging year for the trust as it had delivered a poor financial performance. Gross revenue and net property income declined by 2.1% and 4.7%, respectively. Distribution to unitholders fared worse, falling by 7.7%. Furthermore, the REIT’s net asset value per unit slipped from S$0.634 in 2016 to S$0.593.

Worryingly, beneath these poor numbers are even more aspects of the REIT’s business that suggest that its poor performance in 2017 could likely continue in the future. Here are three characteristics of ESR-REIT that do not bode well for its future and its unitholders.

Poor tenant retention rate and negative rental reversions

For the whole of 2017, ESR-REIT reported a tenant retention rate of just 51.1%. This highlights the challenges that ESR-REIT faced during the year, and the fact that the REIT does not command the same level of stickiness and relationships with its tenants as other industrial REITs.

Furthermore, ESR-REIT experienced a negative rental reversion rate of 15.8% in the year. A negative rental reversion rate suggests that ESR-REIT has limited pricing power with its tenants. Moreover, the negative rental reversion rate will consequently affect the REIT’s rental income in the next few years. This will in turn apply further downward pressure on the REIT’s distributions to unitholders.

High gearing and low interest coverage

The other concern I have is with ESR-REIT’s gearing ratio and interest expense. The gearing ratio is the amount of debt the REIT has in relation to its assets. As of 31 December 2017, ESR-REIT had a gearing ratio of 39.6%, which is dangerously close to the 45% regulatory limit set by the Monetary Authority of Singapore.

As a point of comparison, similar industrial REITs in Singapore such as Ascendas Real Estate Investment Trust (SGX:A17U), Frasers Logistics and Industrial Trust (SGX:BUOU), and Mapletree Industrial Trust (SGX:ME8U), have gearing ratios of 33.8%, 29.3%, and 29.2%, respectively.

Furthermore, ESR-REIT’s interest expense is high compared to its asset yield, as reflected by the interest cover ratio of just 3.5 times in 2017. Add this to the fact that only 69.2% of ESR-REIT’s debt at end-2017 had fixed interest rates, and the REIT is at risk of seeing a big chunk of its bottom-line get eaten away if and when interest rates rise this year.

Short history of new sponsor

e-Shang Redwood (ESR) acquired its majority stake in the REIT’s manager, along with a 12% stake in ESR-REIT, only on June 2017. ESR’s short history as the sponsor and manager of ESR-REIT poses many questions for the REIT and its unitholders.

Does the management team have the know-how and expertise to turn the REIT around? Will the new sponsor have the interests of the REIT’s unitholders at heart? These questions can only be answered as the story develops over a longer time frame.

The Foolish conclusion

ESR-REIT most certainly has been facing many challenges of late. Not only has the financial performance of the REIT been poor in 2017, there are also many characteristics of the REIT that suggest that its business may continue to suffer in the future. Furthermore, it remains to be seen whether the REIT’s new manager and sponsor has the expertise and foresight to turn its ailing fortunes around.

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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. The Motley Fool Singapore has a recommendation on Mapletree Industrial Trust.