Prior to BHG Retail Real Estate Investment Trust’s (BHG REIT) initial public offering (IPO) in December 2015, BHG -was just but another name turning up in the local departmental store space.

Little is known to the unmindful public that the departmental store brand is in fact an entity of China-listed Beijing Hualian Department Store Co (BHG Store); which is part of the China’s retail behemoth Beijing Hualian Group (BHG). The Group was founded in 1993 and engages primarily in operating retail malls, supermarkets, luxury department stores and engaging in international retail partnerships. Today, BHG is one of the 15 largest retail enterprises supported by China’s own Ministry of Commerce and the only Chinese retailer as a board member in the International Association of Department Stores.

Unsurprisingly, BHG REIT – whose sponsor is BHG Store – has a portfolio constructed predominantly with retail properties in China. In the local sphere where retail properties are seeing slower growth and struggling to generate attractive returns for investors, could investing in BHG REIT provide something potentially more lucrative?

Backing Of A Strong Sponsor

In constructing BHG REIT’s IPO portfolio, BHG Store injected five prime community retail properties into the REIT. The properties are located in high-growth cities of Beijing, Chengdu, Dalian, Hefei and Xining which aggregate a gross floor area (GFA) of 263,688 square metre.

BHG REIT is further offered the rights of first refusal for a pipeline of 13 retail properties, by BHG Store. This means that BHG REIT has the first rights to purchase the any of the 13 properties, before the sponsor offers them to the market. Therefore, BHG REIT can expand the GFA under its management – potentially by another 795,542 square metre – should it acquire the 13 properties.

Indirectly, BHG REIT also stands to benefit from the group’s larger network that includes international brands like H&M and Uniqlo. Leveraging on this, the REIT managers can anchor repeat tenants with relative ease, fill its retail mix with popular brands to enhance its malls’ profile and improve footfall. Achieving so, it will be able to appreciate its properties’ revaluations and generate higher rental income. In this aspect, BHG REIT appears to have achieved some success. Its properties, based on preliminary reappraisal as of 30 June 2016, have increased its total valuations to $774 million from $605.9 million as at 30 June 2015.

Debt Headroom For Potential Acquisitions

One very important aspect in the narrative of REITs is gearing. While it is a given that REITs’ gear up to maintain liquidity or make acquisitions, a high interest expense can take a toll on net property income. This is especially so during downturns where REITs face downward pressure for rent revisions. Amongst the local bourse, BHG REIT is one of the REITs with lowest gearing, at 29.4 percent total debt-to-assets.
At such low gearing levels, BHG REIT has relatively more financial headroom to take on more debt for making acquisitions. Under regulations, local listed REITs have a gearing limit of 45 percent. This means BHG REIT has about $104 million of debt headroom for potential acquisitions.

China’s Consumption Can Drive Growth

Despite a slowdown in the global economy, China still commands a respectable 6.7 percent growth in the first half of 2016. Meanwhile, disposable income per capita for urban residents and retail sales continue to rise, growing by 5.8 percent and 10.3 percent respectively.

The country’s future growth trend also bodes well for the REIT. According to China’s 13th 5-year plan for 2016 to 2020, the Chinese economy targets to increase the urbanisation rate from 56.1 percent to 60 percent by 2020. Along the economic and social development blueprint, per capita income is aimed to grow by 6.5 percent annually.

Another major factor, to the benefit of BHG REIT’s growth prospect, is China’s direction to transit towards a consumption driven economy. According to the Chinese Ministry of Commerce, retail sales in China will continue to see robust growth of around 10 percent annually to US$7.2 trillion, by 2020; overtaking America as the largest retail market by 2018.

Not All Bright And Glamour

While the above arguments paint a positive picture for BHG REIT, it is not all bright and glamour. Afterall, unit price of the REIT has fallen 25 percent to $0.60 per unit since IPO. Average volume based on past 30 trading days was also lacklustre; with only about fifty thousand units changing hands per day.

It is probably noteworthy to mention, BHG REIT’s DPU yield would not have been that attractive, had it not been that BHG – as a strategic investor – entered into a deed of distributions undertaking. This means that BHG has agreed to forgo its share of distributions for a number of years; which has artificially inflated the distributions to retail unitholders. Based on the IPO price of $0.80 per unit, projected DPU yield for full financial year 2016 would have just been 4.5 percent.

Source: Company prospectus

Source: Company prospectus

Valuation Seems Highly Attractive

When BHG REIT first IPO-ed back in December 2015, it traded at its net asset value of $0.80 per unit. Today, it currently trades at just around $0.60 per unit, 25 percent lower than its net asset value and making it one of the most discounted counters amongst Singapore’s 38 REITs and stapled trusts. This is despite the fact that its post-listing annualised distribution per unit (DPU) for 1H16, yielded 7 percent (based on trading price of $0.74 per unit on 30 June 2016).

Comparatively, its closest peer, CapitaLand Retail China Trust (CapitaLand Retail China) currently trades around $1.60 per unit, at a 2.9 percent premium against its net asset value. In addition, the annualised DPU yield was also lower at 6.7 percent (based on trading price of $1.61 per unit as at 30 June 2016).

Source: Reitdata; as of 24 October 2016 Annualised DPU Yield = Current Unit Price divided by latest 4 quarters distribution

Source: Reitdata; as of 24 October 2016
Annualised DPU Yield = Current Unit Price divided by latest 4 quarters distribution

It All Boils Down To The REIT’s Managers

It will not be till 2021 when BHG will be fully entitled to its share of distribution. Meanwhile, for the first year of listing, BHG REIT is committed to a 100 percent distribution rate. Assuming DPU for next half of the financial year remains at the same at $0.0285, at the current unit price of $0.60, investors would attain an ostensibly high DPU yield of 9.5 percent (excluding the 0.1 percent of distributions BHG is entitled to).

When the deed of distributions undertaking expires, it is then totally up to the REIT manager’s ability to increase gross rental income and reward unitholders. That said, we note that the REIT has yet to even post a full financial year result for a full inspection. Nonetheless, we opine that investors who believe that the REIT’s growth potential more than compensates for the inherent risk, may consider including BHG Retail REIT as a constituent in their portfolio. If nothing else, the steep price-to-net asset value discount of 25 percent should provide enough margin as protection.