Financial Adviser: 5 Things Every Investor Needs to Know About Ayala Land AREIT’s IPO

Ayala-owned AREIT, Inc (PSE: AREIT) will be the third company that will go public this year after it obtained approval from regulators to raise up to P13.5 billion in an initial public offering.

AREIT will sell up to 502 million shares, consisting mainly of secondary shares from its parent company, Ayala Land, to the public at a f of P27 per share.

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The offering period of AREIT shares will run from July 27 to August 3 with a target listing date on August 13, 2020 and market capitalization of P27.7 billion.

What is AREIT?

AREIT Inc. will be the first real estate investment trust (REIT) in the country after the Implementing Rules and Regulations (IRR) of the REIT Law of 2009 were approved by regulators last year.

Under the new law, a REIT company is required to distribute at least 90 percent of its distributable income as dividends. In exchange, a REIT can claim the dividends as allowable deductions against its taxable income, making it practically tax-free.

Because of the strict guidelines on dividends, REITs provide a steady stream of income to investors, unlike ordinary stocks which do not pay regular dividends.

REITs can also offer competitive dividend yields against preferred stocks because of its ability to expand and grow its income base, resulting to long-term share price appreciation.

But like any investment, not all REITs are created equal.

Some REITs may be riskier than the others because they have less predictable income stream due to their asset quality or financial condition.

If you are planning to buy REIT stocks, it is important that you are not only buying it for the dividend yield. You must also understand the business of the company.

When you know the fundamentals, you will also have a better handle of the risk and return that you can expect from investing in a REIT.

Here are the top five things every investor needs to know about AREIT’s IPO:

1| Know the background of the company

Previously known as One Dela Rosa Development, AREIT is a property company organized as a real estate investment trust (REIT) that invests and manages a portfolio of income-generating assets with the purpose of producing stable returns to investors.

Incorporated by AyalaLand Offices in 2006, AREIT became 90.15 percent owned by Ayala Land (PSE: ALI) in 2018 when it transferred two properties, namely, Solaris One Building and Ayala North Exchange worth P6.9 billion, in exchange for new shares.

In January 2020, AREIT Inc. leased the third property, McKinley Exchange office and retail building from ALI for 34 years. Together, the three income-generating properties, which now comprise the assets of AREIT, are now valued at P27.7 billion based on the AREIT IPO price.

AREIT will sell up to 49 percent of the company to the public for P13.5 billion where 90.5 percent of the proceeds or P11 billion will go to ALI, while the remaining 9.5 percent or P1.3 billion will go to the REIT.

Right after the AREIT's IPO, assuming all the shares have been sold including the overallotment options, ALI’s effective control of AREIT will fall to 51 percent.

2| Know the assets of the business

AREIT’s three properties, which are all grade A and PEZA accredited, are managed by ALI through its wholly owned subsidiaries, AREIT Fund Managers and AREIT Property Managers.

AREIT's three properties are: 

• Solaris One
• Ayala North Exchange
• The McKinley Exchange

AREIT’s first property, Solaris One, is a 24-storey commercial building, which was completed in 2008, while its second property, Ayala North Exchange, is a mixed used development property that consists of two towers completed during 2018 and 2019.

The first tower is a 30-storey building, consisting of a 12-storey HQ office and 18-storey serviced apartments, while the second tower is a 20-storey BPO office designed for 24/7 operations.

AREIT’s latest acquisition, The McKinley Exchange, is a five-storey commercial office leasing that was completed in 2015.

The three properties, whose land is leased from ALI, have a total gross leasable area of 152,755.6 square meters with an average occupancy level of 99.9 percent.

Right after the AREIT's IPO, AREIT plans to expand its portfolio by acquiring a fourth property located in Cebu IT park with a gross leasable area of 17,947.9 square meters for P1.45 billion.

Known as Teleperformance Cebu, this property is a grade A, PEZA-accredited mixed-use development that consists of two BPO office towers completed in 2010.

By the end of the year, AREIT will have a total gross leasable area of 170,703.7 square meters with BPO operations occupying 66 percent of its total spaces, followed by service apartments, 15 percent; HQ offices, 12 percent; and others, seven percent.

3| Know the financials of the company

AREIT’s total revenue base from its two assets, Solaris and Ayala North Exchange, was P1.5 billion in 2019, which generated recurring net income of P937 million.

This year, with the acquisition of McKinley Exchange and later in the year, Teleperformance Cebu, AREIT is projecting that its net income will grow by 30 percent at P1.22 billion.

By 2021, AREIT expects its net income to grow further by 12.5 percent to P1.37 billion with the full year revenue contribution of Teleperformance Cebu.

Because the leases are generally committed by tenants, there is only about 1.2 percent of total gross leasable area that is expected to expire in 2021, and 8.3 percent in 2022. These should limit the risk of rental loss given the current economic recession.

AREIT also pays its land leases to ALI based on gross rental income, enabling the company to enjoy flexible operating leverage. For example, for Solaris One, AREIT pays seven percent based on gross rental income.

Without acquisitions, the main source of revenue growth will be AREIT’s annual rental increases. The weighted average rental escalation rate of AREIT’s properties is about 3.9 percent per year.

AREIT has a strong balance sheet with a high current ratio of 4.4 as of the first quarter this year. The company is also debt-free with zero debt-to-equity ratio.

4| Know the dividend yield of the offer

If we will follow the minimum requirement of REIT law, we can simply multiply 90 percent of the AREIT’s expected income of P1.22 billion to derive distributable income of P1.09 billion or P1.065 per share.

At AREIT's stock price of P27 per share, this will give a gross dividend yield of only 3.9 percent.

But according to AREIT, the company plans to follow the Adjusted Funds from Operations (AFFO) approach wherein the reported net income shall add back its depreciation expenses and deduct any capital expenditures and rental adjustments.

Based on AREIT’s projections, the total distributable income that they can declare for 2020 shall be P1.35 billion or P1.31 per share, which represents 111 percent payout ratio from the forecasted net income.

At this adjusted distributable income, the projected dividend yield of AREIT's stock price is 4.9 percent, or 4.41 percent after 10 percent dividend tax.

Following the same approach, the projected distributable income per share for 2021 is P1.58 per share, which gives a gross dividend yield of 5.9 percent or 5.31 percent net of taxes.

AREIT’s prospective dividend yield at 4.9 percent is comparatively lower than the average yield of preferred stocks in the PSE at 6 percent per annum.

If we compare AREIT’s yield to Singapore REITs, which has the largest REIT market in Asia, it is also lower than the median dividend yield of 7.76 percent.

Nevertheless, AREIT’s lower dividend yield does not necessarily mean that the stock is not good. The lower yield may signify lower risk due to the company’s high asset quality, strong financial position, and earnings sustainability.

5| Know the growth prospects of the company

The total return of investment in REIT is composed of a dividend yield and capital return.

If we assume that the normal yield of AREIT is 4.9 percent and we are expecting that the company will pay higher dividends in 2021 at P1.58 per share as projected, we can estimate the target value of the stock by simply dividing the P1.58 dividend by 4.9 percent to derive P32.2 per share.

At P32.2 per share, this will give a capital return of 22.2 percent.

AREIT's stock price target is still 3.9 percent lower than the net asset value of AREIT, which is computed at P33.51 per share as of first quarter of this year.

The capital appreciation potential of AREIT will depend on how it will grow its dividends by expanding its investment portfolio in the future.

AREIT can potentially tap two sources of financing. One is by debt financing and the other is through the sale of its treasury shares.

Given AREIT’s debt-free financial position and average gearing ratio of 35 percent of REIT companies in Asia, the company can borrow up to P5.1 billion against its projected total assets at P14.5 billion.

Using the projected rental yield of Teleperformance Cebu at 9.5 percent, we can estimate the potential rental revenues of P484 million if the company uses debt to acquire more assets.

AREIT can also sell its 67 million treasury shares to raise funds. At P30 per share, the company can potentially raise P2.0 billion to expand its portfolio.

At minimum rental yield of 9.5 percent, new acquisitions can generate additional P191 million in rental revenues, which should enhance AREIT investment returns.

Although AREIT Inc. has the resources to expand, it may be challenging for the company to grow at this time of economic uncertainty.

Buying the stock for competitive yield and long-term capital returns can be a good defensive investment strategy to navigate this crisis.

Henry Ong, RFP, is president of Business Sense Financial Advisors. Email Henry for business advice [email protected] or follow him on Twitter @henryong888 

What are REITs?

REITs are essentially corporations that manage real estate assets that produce regular income such as hotels, apartment buildings, office and commercial buildings, and shopping malls. According to the SEC, besides providing real estate companies a cheaper source of capital and promoting economic development, growth in tourism and liquidity in the capital markets, REITs allow both small and large investors to participate in the direct ownership of real estate and is an alternative investment instrument to foreign investors as well as OFWs. 

Is AREIT a good investment?

A good investment portfolio is a diversified investment portfolio. The advent of REITs now allow investers to enter the real estate market without buying property. Thus, investing in any REIT like AREIT Inc. is a good way to diversify your wealth.