Distributions of 7%, paid monthly

Co-founder of the Switzer Report
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Despite the threat of higher bond yields, the listed real estate sector continues to perform quite strongly. After a soft start to the year, the S&P/ASX 200 real estate sector returned 7.57% in April and May, to be in the black for the year with a total return of 1.86%.

Support for listed property trusts reflects the strong demand for commercial property, particularly in the Sydney and Melbourne CBD markets, where vacancy rates are low and rents have moved higher. Further, interest rates in Australia seem to be going nowhere quickly, with the RBA cash rate stuck at 1.5%.

An alternative to investing in a listed property trust is to invest in an unlisted trust. Typically, these pay higher yields than listed trusts, are either single asset or own a less diversified mix of property assets, and are smaller in size. The trade off, of course, is that there is no liquidity, so investors typically agree to a timeframe upfront for an exit path to sell the assets and wind up the fund.

There are several property managers who develop unlisted property funds, including Charter Hall, Centuria and Australian Unity. One of the latest unlisted funds is the Centuria 80 Grenfell Street Fund.

Centuria 80 Grenfell Street Fund

The Centuria 80 Grenfell Street Fund is acquiring a 50% interest in 80 Grenfell Street, Adelaide. The other 50% will be owned by an entity associated with Paul Lederer.

Completed in 2013, 80 Grenfell Street is a modern, award winning A-grade commercial office building in central Adelaide, situated above Rundle Place and overlooking Rundle Mall. It has 23,440 sqm of net lettable area over 11 office levels, plus 98 car spaces.

The property features a 5-star NABERS Energy rating, 5-star Green Star rating, high quality tenant fit out, good natural light and sweeping views over Adelaide. It is one of only two buildings in Adelaide with floorplates over 2,000 sqm. Capital expenditure requirements are forecast to be minimal.

The property is 96% leased to Bendigo and Adelaide Bank, with over seven years remaining on its initial lease term. Fixed annual rental reviews of 3.75% are also incorporated into its lease.

The purchase price for the building of $184.6 million (the fund’s share is $92.3 million) represents an initial passing yield of 6.7% and a market capitalisation rate of 6.3%.

Fund metrics

With stamp duty, hedging and other costs, the total transaction cost (for the fund’s 50% share) is $98.6 million. The fund will borrow approximately $41.5 million (fixed for 3 years), with unitholders to contribute the balance of $57.1 million through the issue of 57.1 million $1.00 units. Based on an independent valuation of the property, the fund will have an initial loan to valuation ratio (LVR) of 45.0% and an initial net tangible asset value (NTA) per unit of $0.93.

For unitholders, the manager (Centuria Property Funds Limited or Centuria) forecasts the following distributions:

* Annualised, for the period 1 August 18 to 30 June 19.

Distributions will be paid monthly to unitholders. They are expected to be tax advantaged to the extent that they will be 80% tax deferred in 18/19 and 70% tax deferred in 19/20. (Tax deferred income is not assessable for income tax, but does reduce the cost base for CGT purposes).

Investment rational and exit plan

In addition to the forecast distribution yield, long term lease to Australia’s fifth largest bank with annual rent increases of 3.75%, modern A-grade office building with minimal capital expenditure required, Centuria says that the Adelaide prime grade CBD office market is attractive on a relative basis.

Adelaide offers a 2% yield premium over Sydney and Melbourne, with prime grade assets in Adelaide yielding around 6.9% compared to around 4.9% in Sydney and 5.0% in Melbourne. South Australia is currently enjoying above average growth in state final demand and there is currently limited prime stock available within Adelaide. A new Adelaide CBD building, Charter Halls’ GPO Exchange, is 90% pre-committed, supporting the assertion that Adelaide has a balanced office supply outlook.

Bendigo and Adelaide’s lease is due to expire in November 2025, approximately two years after the fund’s initial term of five years. Renewal of this lease could have a major impact on the valuation of the property, so the manager may attempt to secure this earlier. Centuria says that Bendigo and Adelaide Bank is on its first lease term with a large fit out investment, consequently there is a “high probability of lease renewal”. This is further supported by the ‘cap and collar’ arrangement in place, which means that the new rent cannot be more than 10% higher or lower than the old rent.

The initial term of the fund can be extended for a further two years by a majority of unitholders voting in favour to do so. After that, it requires a unanimous resolution of all investors.

The manager is incentivised to maximise returns for unitholders, by potentially earning a performance fee of 20% of any excess return over an internal rate of return of 8% to unitholders (in cash). The manager is also entitled to a base management fee of 0.80% pa (plus GST) of the gross asset value and a disposal fee of 1.0% (plus GST) of the sale price.

Our view

The forecast distribution of 7% per annum in year one, rising to 7.2% per annum in year two, paid monthly, is attractive. Although the interest rate on the debt facility has only been fixed for three years, with such a strong tenant and guaranteed rent increases, the income position of the fund looks secure during the term of the fund.

The other consideration is the fund’s exit strategy, which could rely on renewing the tenancy of Bendigo and Adelaide Bank and a sale of the building. Due to the initial rent, and the cap and collar arrangement for any rent renewal, the prospects of unitholders enjoying strong capital returns are less likely.

Like all unlisted trusts, it is an illiquid investment. The minimum investment is $50,000, and as there is no cooling off period, potential investors should read and consider the Product Disclosure Statement carefully. This is available from Centuria at http://centuria.com.au/adelaide. The offer is scheduled to close on 6 July, but is operating on a ‘first come, first served basis’ and will close when fully subscribed.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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