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Morningstar | Link REIT: Another Successful Disposal, but Does the Market Take This for Granted Now?. See Updated Analyst Note from 13 Dec 2018

Link REIT disposed of a portfolio of assets to a real estate fund for HKD 12 billion. The disposal price was more than 30% above the book value, which was based on the latest valuation in September 2018. The disposal price exceeded our expectations. To account for the impact of the disposal, we lower our earnings estimate slightly for fiscal 2020 and beyond, owing to the loss of rental income. We assume a small portion of the proceeds will be deployed for unit buyback, with the remaining available for additional acquisitions. We raise our fair value estimate to HKD 70 from HKD 64, while maintaining our narrow moat rating, as the original Hong Kong portfolio still contributes most of the earnings.

The disposal consists of 12 properties totaling 580,000 square feet of internal floor area and 4,800 car parks, representing 5% of its Hong Kong retail portfolio. The assets fetched a high premium over book value of more than 30%. While lower than the previous round of disposal at 50% premium, this is still surprisingly high given the current capital market conditions. Most of these assets are mature stable properties with several rounds of asset-enhancement initiatives in the past. The disposal price represents a net yield of 2.9%, a very high valuation given the limited future value-add opportunities.

We adjusted our earnings forecast downward by 4% to account for the disposal. We project the company to do a small amount of unit buybacks in fiscal year 2019 as the loss of earnings were small as well as high unit price. The contribution from newly acquired assets in Beijing should allow for continued earnings growth. Following the disposal and recent acquisition in Beijing, the Hong Kong portfolio is expected to contribute 85% of total earnings. Contributions from China are likely to grow further as the company’s strong balance sheet is capable of taking on new acquisitions.

The company’s portfolio in Hong Kong is now fairly mature, and unlikely to match the strong earnings growth seen in the past. Future growth will be reliant upon continued capital recycling. However, we caution that the capitalization rate seen in the most recent transaction is very tight. As the REIT market generally leads the private market, an increasing number of REITs and landlords selling assets into the private market can be viewed as an indication that the commercial real estate market is heading into a downcycle. The institutional buyers in this transaction may be attracted to mature and stable assets that are less management-intensive, but such assets are the most vulnerable to a potential capitalization-rate expansion. It is unlikely the company can get such a good price for future disposals.