United Hampshire US REIT - Mistakenly Punished

As per my first portfolio update, United Hampshire US REIT is currently the smallest holding I have in my portfolio. That doesn't mean my conviction in it is the least though. For those out of the loop, United Hampshire REIT is a retail REIT listed on the SGX Exchange with a trailing yield of a whopping 10.684% at its current price of 0.515 USD per unit. This is a drastic decrease from its initial IPO price of 0.80 USD per unit back in March 2020. 

So.... what gives? What could have possibly resulted in this heavy decline in share price? Well, if you haven't noticed, its IPO date of March 2020 coincided with the period when COVID-19 worries began to balloon. This unfortunate timing certainly did not help with its share price, especially when its portfolio mainly consists of US strip malls, which were an asset class that had arguably the most potential to be affected by the pandemic, with the possibility of the US government forcing malls to shut down in a bid to 'flatten the curve'. 

Here's an introduction to the REIT:

"Listed on the Main Board of the Singapore Exchange Securities Trading Limited on 12 March 2020, United Hampshire US REIT is a Singapore real estate investment trust ("REIT") established with the principal investment strategy of investing in a diversified portfolio of stabilised income-producing grocery-anchored and necessity-based retail properties ("Grocery & Necessity Properties") and modern, climate-controlled self-storage facilities ("Self-Storage Properties") located in the United States of America ("U.S."). United Hampshire US REIT tenants are e-commerce resistant, with majority of their anchor tenants of Grocery & Necessity assets utilising their physical stores for their omni-channel strategies."

Screen-grab of United Hampshire US REIT's Portfolio Breakdown on their Website

The above information illustrates one of the unique selling points of UHREIT. The fact that most of its properties are leased to grocery giants such as Publix, which would do well regardless of economic conditions. Not only that, but most of its portfolio is freehold too, a Singaporean's dream come true. I am pleasantly delighted by the fact that most of the REIT's assets will continue to generate free cash flow (presumably) indefinitely. 

Okay... All seems well and good KOPL, but why does the market price UHREIT at a discount in the first place? Confirm have some sort of potential insolvency event right?

Let's take a look at UHREIT's debt profile and see whether it's at risk of insolvency, shall we?

"As at 30 June 2022, the Group has total gross loans and borrowings of US$272.1 million (31 December 2021: US$275.1 million) and US$17 million (31 December 2021: US$14 million) undrawn revolving credit facility to meet its future obligations. The interest rate on the TL1 and TL2 facilities have been hedged using floating-for-fixed interest rate swaps. The weighted average interest rate on loans and borrowings as at 30 June 2022 was 3.03% (31 December 2021: 2.63%) (taking into account the interest rate swaps but excluding commitment fee on the undrawn revolving credit facility). Aggregate leverage, as defined in the Property Funds Appendix, as at 30 June 2022 was 38.0%. Interest coverage ratio as at 30 June 2022 was 6.0 times in accordance with the requirements under its loan facilities and 4.6 times in accordance with the Property Funds Appendix of the CIS Code. As at 30 June 2022, the Group’s current liabilities exceeded its current assets by US$37.5 million. The Group is in a net current liability position mainly due to TL1 and RCF, which are maturing in March 2023. Notwithstanding, the Manager is confident that the outcome of refinancing negotiations with the lenders to refinance these borrowings will be favourable and will be completed prior to the loan maturity date."

When you take a look at UHREIT's debt profile, it does indeed seem scary. Over 230 USD Million worth of debt maturing in the next two years or so. It's also daunting when you realise that the weighted average interest rate on loans and borrowings is 3.03%. That's rather high for a REIT, albeit expected since it is a small cap. However, all these terms become rather opaque and irrelevant once you consider the relatively new information below:

It now seems like the REIT has no outstanding debts until 2024. Hooray! Also, notice how the debt amount for this refinancing exercise is approximately $250 Million USD. Since they didn't give me much information regarding the new refinancing, I can only guess. My theory is that the $250 Million figure includes interest payments (which was can be deduced from the fact that it is the total amount payable should the entire loan be settled in one go which would include the interest from the loan's lifespan), which would roughly coincide with all of the REIT's loans maturing from 2023 to 2024. I speculate that they have entered into a fixed-rate refinancing agreement with a ladder of loans ranging from 2024 to 2026. Of course, I could be horribly wrong, but we'll know soon enough when the REIT publishes its finance report on February 22.

If my (educated) guess were to be true, then it would position UHREIT advantageously since I estimate that the Fed will start cutting interest rates by 2025, if not 2024 as long as they can tame inflation soon enough. However, since the REIT refinanced rather late in the game, the borrowing costs are probably rather high, which I estimate to be around the 3.75% range. This has a probable material impact on the DPU of around 5%, although this is just a shot in the dark from me. 

Overall, I don't think UHREIT has any material risk of insolvency, evident from the fact that its loans should be relatively well-spaced out. Of course, I couldn't make this claim without looking at the performance of UHREIT's assets, which is what I'll be discussing next.

To avoid insolvency or forceful liquidation of assets, one should be able to fulfill their contractual debt obligations. To do this, it is imperative that one be able to generate enough cash flow to cover interest payments and amortisation and to have a decent debt profile. We've covered the latter, so let's see how is UHREIT's performance regarding the former. 

Net income after tax rose by 21.0% from 13.3 USD Million to 16.1 USD Million from 1H21 to 1H22, with revenue increasing by 18.5% from 26.80 Million USD to 31.75 Million USD, which outpaced operating expenses which rose from 8.45 Million USD to 9.30 Million USD. A commendable performance for 1H22. This leaves the interest coverage ratio at around x4.75. Relatively okay in my opinion, although there still is much to be desired.

To ensure that UHREIT's cash flow is not easily disrupted, it is wise to check its portfolio diversification via asset type, location, and tenant makeup. 

All of UHREIT's assets are located in the United States, so if there's any major negative geopolitical incident that occurs there, then the REIT's share price will surely take a hit. That said, UHREIT's tenants are rather well diversified, ranging from the consumer staples sector to consumer discretionary. 

Besides Self Storage, Discounters, Fitness, and F&B, I think it is safe to say that the majority of tenants will continue to do well in an economic recession or inflationary environment. And hey, if the economy's doing better than expected, then money will surely flow into those aforementioned tenants, everyone wins! If you're worried about the fact that UHREIT's top ten tenants are worth 59.3% of GRI, then don't. After all, most of them are supermarket behemoths that hardly go bust. Self Storage is a sector that I'm keeping a close eye on, given that it is no secret that property prices have been on a roll recently, increasing constantly. Indeed, it seems like the American Dream may soon be renamed to the "Pipe dream" when Americans will no longer be able to cough up cash for extra space. In that aspect, Self Storage may be the panacea to that issue, and consequently, positive rental reversions. 

Now that UHREIT's finances are out of the way, let's take a look at its management, shall we?

Firstly, it'll greatly benefit you to know about the two sponsors of this REIT, namely UOB Global Capital and The Hampshire Companies. Yes, that UOB, United Overseas Bank. Its outlets are a common sight in both the heartlands and CBD of Singapore and probably need no introduction. Hampshire Companies is probably the sponsor that's designated as the unknown of this equation. 

"The Hampshire Companies, LLC currently owns and operates a diversified portfolio of 150 properties across the U.S. with an AUM in excess of approximately US$2.0 billion in value and totalling over 11.8 million square feet."

Although US $2 Billion is nothing to scoff at, you can't help but admit that that's a really low number relative to the typical S-REIT sponsors such as Mapletree and Capitaland, which manage 78.7 and 60.0 Billion SGD respectively. This would signify that Hampshire Companies would have significantly less negotiating power when it comes to acquisitions, financing terms, and asset injection capabilities. On the flip side, it is very obvious that this company is under the majority control of the Hanson family, with the appointed CEO being James E. Hanson II. Fancy.

"Presently, his extracurricular activities include: a Council Member of the New Jersey State Investment Council, which oversees $80 Billion New Jersey State Pension Systems; an Executive-In-Residence and Co-Chair of the Board of Advisors for the Center of Real Estate Studies at Rutgers Business School; a Commissioner of the Palisades Interstate Park Commission; and member of the Board of Directors of Lakeland Bancorp, Inc. and Lakeland Bank. Mr. Hanson has a B.A. degree from Hope College and a J.D. degree from Vermont Law School."

Clearly, he seems rather well-connected, and I do not doubt his ability to utilise his connections and knowledge to secure advantageous terms and deals for the REIT. Just to further bring home the point, there seems to only be a grand total of 15 positions on the New Jersey State Investment Council, impressive!

Additionally, it seems like the management fee structure is in a way that aligns with shareholder interests, coinciding with the performance of the REIT.

The base fee for the management is 10% of the annual distributable income whereas there is also a performance fee of 25% of YoY distributable income increases. This incentivises the management to perform, given that they'll be entitled to a hefty paycheck should they improve the performance of the REIT. It is also interesting that the management can take their payment in units or cash, and most of them chose units, so make of that what you will. A good thing to note is that they do have acquisition fees of 0.75% from its sponsor and 1.00% from third parties alongside a divestment fee of 0.5%. Overall, I feel that the management fee structure is rather in line with my wants and needs.

It sounds like a fantasy. Great yield in a defensive sector led by seemingly experienced, professional, and well-connected management. But before you get riled up with the prospect of making fat stacks, I do admit there are some things to take note of. 

Firstly, I think it's safe to assume that everyone wants growing dividends. Look at most REIT analysis articles or videos and you'll be hard-pressed to find one that doesn't talk about uptrend in DPU. DPU depends on profit, which depends on revenue and operating costs. I don't think you'll find many opportunities to reduce REITs' operating costs, but the world is your oyster when it comes to increasing revenue. Of course, positive rental reversions are one way to increase revenue, but most REITs choose to acquire new properties to boost their rental income. Acquisitions... surprisingly, need capital. UHREIT is currently trading at a price-to-book value of 0.681, which allows it to generate that above 10% dividend yield. It is precisely the fact that the REIT trades at a discounted price that allows it to hit that double-digit yield. You aren't going to find cap rates ranging that high in the market, especially freehold, supermarket-anchored retail buildings. So what does this mean for UHREIT? This means that to acquire new properties, the REIT will just have to slowly bide its time and use the income to reduce gearing, do a rights issue or recycle assets. But none of those options could ever possibly provide a yield accretive result. Hence, it would make much more sense to simply return cash to shareholders directly. The heavily discounted price may also open up talks of privatising the REIT, despite its short lifespan on the SGX market. 

Secondly, you may not know this, but UHREIT's gearing ratio is a whopping 42.1%. Just shy of the Monetary Authority of Singapore's (MAS) 50% gearing limit for REITs. Usually, this wouldn't be a problem, but with rising interest rates, we may see US property prices come down soon, which includes UHREIT's assets. Since gearing is calculated by Total Debt/Total Assets, should asset value fall, gearing will inevitably rise. When that gearing ratio rises... it's fire sale time. The REIT will be forced to liquidate assets at huge discounts given that reducing the gearing is of utmost priority. We've seen this play out with Manulife REIT, and we can't rule out the possibility that UHREIT might be next. 

Lastly, you'll have to be comfortable with Forex risk. The REIT's price, earnings, and everything else is in USD. You'll spend USD to purchase units, and you'll get USD as your dividends. We live in Singapore, though. Hence, we use Singapore Dollars. Are you confident in the US' ability to be a strong exporter? Do you buy into the American eternal economic powerhouse story? Sure, USD/SGD is high currently due to the high-interest rates, but it won't be like this forever. 

That USD/SGD chart does not look pretty.

Personally, I think we'll remain at this level for a long time. Nevertheless, you have to accept the risks when thinking about US stocks. 

So, after listing all these points, why do I say that UHREIT is mistakenly punished by the market?

It's because, to me, I think most of these risks are rather minimal. Forex risk is pretty much standard for every single stock. Many REITs and stocks listed on the SGX exchange have some sort of exposure to foreign currency. The USD is the world's reserve currency, after all. Additionally, UHREIT's asset valuation still has to drop by around 16% as a whole to breach the gearing ratio limit. That's a pretty high number which I find rather hard to materialise given the defensive and freehold nature of UHREIT's properties. Lastly, I am fine with dividends not growing much. Positive rental reversions are still a thing and reinvesting dividends is possible, even encouraged via the REIT's new scrip dividend scheme, which allows shareholders to receive their dividends in units. I think not many people are familiar with the US REITs, which may result in UHREIT being lumped together with the US Office REITs. I think even factoring the various considerations such as the REIT being a small cap, and other risks, it still has a rather significant upside. 

Let's check if it's undervalued then, shall we?

Sorry to burst your bubble, but there's not much information we can compare with when it comes to UHREIT. It's the first US supermarket-based REIT in Singapore, and it's only been recently listed. But I'm sure you can agree with me when I say that over double-digit yields is a steal given the fact that there are no significant pressing issues afflicting this REIT. The REIT is priced at x6.1 PE ratio, and I don't see it going much lower than current levels. 

The closest comparison I could find would be Supermarket Income REIT, which has taken a nasty plunge of around 25% after concerns about the UK's debts became widespread. Even after the current discount, it's still trading at a PE ratio of 8.70 and a dividend yield of 6.07%. Previously, notwithstanding UK-related drops, it would have traded a PE ratio of around 12. You can't tell me that the higher market cap warrants almost double the PE valuation. Even if you were to use the current limited data that we do have, it paints UHREIT in a favourable light. Net Property Income and Distributable Income have been rising with efforts being made to reduce gearing. Overall, UHREIT's performance has not declined whereas share price did. This indicates that it is technically historically undervalued.

Overall, here are some of my parting thoughts. 

I think UHREIT is one of the best deals you can get in the Singapore market right now. The risk-to-reward ratio is pretty low with significant upside in both price appreciation and dividend yield. I am seriously considering going overweight on this counter and am planning to add more to it in the near future. My conviction in my investment thesis here potentially supersedes my confidence in Keppel Corporation, a blue-chip company. Overall, I think it's a solid buy, but I foresee the short-term price struggling if the Fed becomes more hawkish. Nevertheless, I'll be looking to accumulate if prices remain low. 

Author's Note:

This was definitely my longest article to date, and I must admit that doing that much research demotivated me a bit. I hold a high level of respect for content creators who push out quality articles, videos and podcasts on a regular basis. Do comment if you gained some insights or enjoyed this article, thank you all!

Disclaimer: Please take everything published within this blog with a pinch of salt. Nothing I say here should be misconstrued as any form of financial advice whatsoever. In fact, I am probably the absolute last person you should approach for any sort of advice. All self-computed figures are calculated to the best of my ability, but I cannot guarantee they are 100% accurate.

Thank you for reading my blog, and I hope you have learnt something, no matter how seemingly minuscule. I would greatly appreciate it if you subscribe as such posts take a decent chunk of time to dish out, ciao!