Healthcare REITs (real estate investment trusts) are among the most stable income-providing investments available. This is due to the inelastic businesses of their tenants and the specialized buildings that their tenants require. For example, a hospital cannot set up shop in any empty retail space or office building. Because of this, healthcare providers are unlikely to close up shop and move when a lease expires. The inelastic nature of the healthcare industry also provides steady cash flows for their tenants regardless of economic conditions. After all, a person that needs medical care is going to get it no matter what is going on in the economy. Therefore, it is unlikely that an economic downturn will result in a tenant being unable to pay the rent. This is important for the trust because the trust needs to have the rent checks coming in so that it can afford to pay out high distributions to its investors. In this article, we will take a closer look at one such trust, Singapore's First REIT (OTC:FESNF).
First REIT was the first healthcare REIT to be created in the Asian city-state of Singapore, first being listed on the Singapore Stock Exchange on December 11, 2006. The trust currently owns fourteen healthcare properties located in Singapore, South Korea, and Indonesia. These fourteen properties consist of eight hospitals, one integrated hospital and hotel, and one hotel and country club in Indonesia, the latter of which is the only non-healthcare facility in the trust's portfolio. The remaining properties consist of three nursing homes in Singapore and one hospital in South Korea.
Source: First REIT
These fourteen properties contain a total of 3,664 beds spread over 227,376 sq. m of floor area. As of December 31, the total value of all of these properties is S$1,052.3 million.
One of the nicest things about First REIT's portfolio is that it has a 100% occupancy rate. This is a relative rarity among REITs in general and it means that every square meter in the trust's property portfolio is currently generating rental revenue for the trust. This means that the trust is currently producing the maximum revenue that it can from its property portfolio. Unfortunately, it also means that the trust cannot increase its revenue by simply leasing out its unused space. It can only grow by buying new buildings or by increasing rent on its current tenants. This is not a bad thing though and the trust has several promising properties in its acquisition pipeline which will be discussed in just a few moments.
First REIT does, in fact, increase the rents that its tenants have to pay under their leases every year. The size of the rent increase varies depending on which country the leased property is in. In both Singapore and South Korea, each of the trust's properties carries a fixed base rent and this fixed base rent increases by 2% per year. In Indonesia though, it works slightly differently. As in Singapore and South Korea, every property carries a fixed base rent. This fixed base rent increases annually by double Singapore's CPI (consumer price index), up to a maximum of 2%. In addition, there is an additional variable growth component levied on the tenants that is calculated using a formula that incorporates the total gross revenue of the trust's assets in Indonesia.
As the trust operates in three countries, it would ordinarily be exposed to currency fluctuations which could result in greatly fluctuating year-over-year and quarter-over-quarter results despite the inherently stable nature of the trust's business. However, First REIT has taken steps to mitigate that risk. One way that it has done this is to require all of its tenants in Indonesia to pay their rent in Singaporean dollars. In so doing, the trust has passed the risk of currency fluctuations onto its tenants located on the archipelago. Thus, the trust has essentially no exposure to the Indonesian rupiah to Singapore dollar exchange rate other than the effect that such currency fluctuations may have on the values of its properties in the country.
That just leaves South Korea. The trust's South Korean property makes up a relatively small portion of its portfolio so the trust's revenues would not be as affected by fluctuations in the South Korean won relative to the Singapore dollar as such revenues would be by exposure to the Indonesian rupiah relative to the Singapore dollar (had the trust not mitigated that risk). Nevertheless, First REIT has also mitigated its exposure to the South Korean currency by requiring its tenant there (the Sarang Hospital) to pay its rent in U.S. dollars. This has, naturally, given the trust some topline exposure to fluctuations between the U.S. and Singapore dollars. When the U.S. dollar appreciates relative to the Singapore dollar then it will have a positive impact on the trust's revenues and vice versa. This chart shows the SGD/USD exchange rate over the past year:
As the chart shows, despite significant volatility, the Singapore dollar overall declined slightly against the U.S. dollar over the past year. This means that the revenue that First REIT earned from its property in South Korea increased over the past year due to currency fluctuations. Should this trend continue, First REIT will continue to see its reported revenues increase independently of the rental increases levied on the South Korean tenant. Of course, if the trend reverses then First REIT may see its reported revenues fall even though the rents are still increasing in U.S. dollar terms.
As previously mentioned, the impact on First REIT's revenue caused by fluctuations between the Singapore and U.S. dollars is likely to be minimal. This is because only 2.4% of the trust's rental revenue comes from South Korea.
Source: First REIT
Thus, even if the U.S. dollar fell so far against the Singaporean dollar that it essentially wipes out all the revenue from this property in Singaporean dollar terms (for example, a hyper-inflationary situation) then the trust's revenues will only decrease by 2.4% in reported terms. As this is the worst case scenario and it is incredibly unlikely, it should be obvious that the real risk here is minimal.
These annual rental increases combined with the trust's acquisition of some properties recently have allowed it to considerably increase its distributable income over the 2013-2014 period. In the fourth quarter of 2013, the trust increased its distributable income and distribution per unit by 26.2% and 14.5% respectively compared to the prior year quarter. In addition, the trust's distributable income for the full year 2013 increased by 24.9% compared to 2012 and its full year distribution per unit increased by 14.3% year-over year.
Source: First REIT
There were two primary drivers of this growth, one of which will result in further growth in 2014. The first driver of growth was two properties that First REIT acquired in November 2012. These two properties are Siloam Hospitals Manado & Hotel Aryaduta Manado and Siloam Hospitals Makassar, both of which are located in Indonesia.
Source: First REIT
As these two properties were both acquired in November 2012, they had very little time to meaningfully contribute to First REIT's results in that year. This was not the case in 2013 as both properties collected revenues for the trust in the form of rents in each of the twelve months of the year. This resulted in substantially higher revenue generation for the trust from these two properties in that year.
The second driver of growth will also serve to provide growth for the trust in the 2014 fiscal year. This driver is two properties that First REIT acquired in May 2013. These two properties are Siloam Hospitals Bali and Siloam Hospitals TB Simatupang, both are which are also located in Indonesia.
Source: First REIT
The acquisition of these two properties began to generate rental revenue for the trust in May 2013. Therefore, the trust only received rental revenue for part of the 2013 fiscal year and not for the entire year. This changes in 2014 because this will be the first year that the trust will have owned these properties for the entire year and so will have collected rent for the entire year.
We can already see evidence of the growth that these properties will produce by comparing First REIT's first quarter 2013 results with those of the prior year quarter. In the first quarter of 2014, the trust's gross revenue increased by 28.3% over the prior year quarter and total return after tax increased by 25.7% compared to the first quarter of 2013. The primary reason for this growth was the presence of these two buildings. As both properties were purchased in May 2013, neither one was owned by the trust in the first quarter of last year. Thus, naturally, the trust would not earn any money from them. This was not the case in the first quarter of 2014. Furthermore, these are the only two properties that the trust acquired last year. So, while a small amount of this growth came from rent increases, the largest portion came from the acquisition of these two properties.
First REIT is likely to continue its growth this year through the acquisition of another property, Siloam Hospital Purwakarta, also located in Indonesia. The trust announced this acquisition on March 14, 2013 but did not specify when it expects the transaction to be complete. Regardless, the trust is typically able to complete these transactions fairly quickly due to its relationship with Lippo Group. The property will be purchased by the trust at a relatively large discount to its fair market value. The trust is paying S$31.0 million to obtain this property, approximately a 17.3% discount to the hospital's fair market value according to two independent valuations. This is quite positive for the trust's unitholders as it will be immediately accretive to the trust's NAV by the amount of the discount.
The fact that the trust is purchasing the property at such a large discount to its independent valuation has the effect of increasing the yield that the trust will earn from the property. According to OCBC (linked above), the purchase price of S$31.0 million gives the trust an NPI (net property income) yield of 10.8% or approximately S$3.35 million per year. This is slightly higher than the NPI yield on the last four Indonesian properties that the trust acquired which had an average yield of 10%.
The trust will be financing the acquisition partially through the issuance of new trust units and partially by taking on debt, with the debt providing the majority of the funding. The trust will take on S$26.5 million in debt and will issue S$4.5 million worth of new trust units to finance the acquisition. Due to the issuance of the new trust units, the existing unitholders will be diluted somewhat and so will not receive quite as much benefit from this acquisition were it entirely funded with debt but the purchase of this property will still be beneficial for existing unitholders. OCBC sees the trust's gross revenue increasing by 1.9% in 2014 year-over-year due to the purchase of this property. However, 2015 should see even further growth from the acquisition of this property because that is the first year that the trust will see a full four quarters of rent checks coming in from the property. OCBC projects that gross revenue will increase by 3.6% year-over-year in 2015 due to the purchase of this property.
However, there are other factors which were already discussed that should also result in forward revenue growth. Because of all of these factors, gross revenue is projected to increase by 12.0% year-over-year in 2014 and then by an additional 3.75% in 2015 over 2014. This should also result in growing distributions for unitholders, which are projected to increase by 10.7% year-over-year in 2014 and then by an additional in 2015 over 2014.
The trust also has additional sources of forward growth due to the six properties in its acquisition pipeline.
Source: First REIT
First REIT has not announced the acquisition dates of any of these properties nor has it provided any other information about them other than to say that it is looking at them and that it has the right of first refusal to all of these properties. This means that there is no chance that any other REIT or other investor could purchase any of these properties without First REIT declining to purchase the property in question. Therefore, all six of these properties will likely soon be a part of First REIT's portfolio assuming that the price is fair. This provides First REIT with very strong future growth prospects and this will likely result in forward distribution growth for investors.
Of course, First REIT already has a very appealing distribution yield. At the time of writing, the trust units trade for S$1.125. The trailing distribution from the 2013 fiscal year is S$0.0752 per unit. This gives the trust a trailing distribution yield of 6.68%. The trust increased its distribution somewhat following the first quarter of 2014 to S$0.0199 per unit per quarter. This works out to S$0.0796 annualized which would give the trust an annualized 7.07% yield at the current price. However, as already discussed, OCBC projects that the 2014 distribution will be a total of S$0.083. If it is correct, the trust would have a forward distribution of 7.37% at today's prices. This distribution combined with the trust's forward growth prospects could offer a very promising opportunity for investors seeking safety, income, and growth.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am considering acquiring a long position in First REIT but it will not be within 72 hours of publication.
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