Elite Commercial REIT High Dividend Yield of 7% But May Not Be As Safe As One Thought- 3 Things To Watch Out For.

Elite Commercial REIT ("EC REIT") debuted in early 2020 on SGX mainboard at GBP 0.705 per unit which is 3.7% higher than its IPO price of GBP 0.68 per unit. Ever since then (in particularly the last 52 weeks), its price has hovered mostly between GBP 0.610 per unit to GBP 0.680 per unit. Most recently, it was announced that its major tenant, the UK government, has agreed to the removal of "break clauses" for its rented properties from EC REIT during negotiation which thus translates into a long and stable WALE of around 5.5 years as of March 2022. The current 7% dividend yield is one of the highest among the Singapore REITs. The UK government also seemingly appears to be an AA-rated solid tenant and the lease is on triple net lease basis. However, I am staying away from Elite Commercial REIT due to 3 main concerns which I will further elaborate below.

1. 99 per cent of its gross rental income came from from leases with the UK government, primarily DWP (Department for Work & Pensions) which is the largest public service department
Concentrating 99% of its gross rental income on the UK government is actually a double edged sword. Since 2001, the UK government has been running a budget deficit. UK's Public sector debt excluding public sector banks was at GBP 2.34 trillion at the end of March 2022, or around 96.2% of GDP. It’s now at levels not seen since the early 1960s. Hence there is a real risk that there maybe governmental fiscal structural reform.  

While I do not think that the UK government will default on its rental payment, there is a strong likelihood that if the fiscal situation worsened in future and things become unsustainable, then there maybe a "re-negotiation" with EC REIT that may result in a substantial haircut to rental rates. Look at what happened to First REIT and its master and main tenant Lippo Karawaci in Dec 2020 and I cannot help but get this Deja Vu feel.

In addition, what if the UK government decided to give up half of the properties in future and make use of online technology to service citizens? EC REIT's marketing team will have a very exciting time trying to search for new replacement tenants. The lack of diversification of non-government tenants is worrisome. Hence having 99% of gross rental income coming from the AA rated UK government is really a double edged sword- it can cut the other way just as easily.

From the Q1 2022 updates, we are already seeing some of the government properties being given up

Note that a total of 8 properties making up around 4.8% of FY2022 contractual rental are now at stake for FY2023. EC REIT is pondering a variety of options for each of these properties, including re-letting as an office or other uses, disposal with vacant possession or following re-letting, and seeking consent for alternative uses such as redevelopment.

2. Weak bargaining power in negotiation since major tenant (UK Government) took up bulk of its commercial properties
As evident from the latest negotiation with the DWP, the rental rates offered for 11 properties were being reduced. I find this very strange and disturbing given the assertion that UK rental market is resilient and that the Consumer Prices Index ("CPI") rose by 7.0% in the 12 months to March 2022.

3. Forex currency conversion risk

I do not think we need to delve too much into this forex issue. EC REIT is listed in pounds and functional currency is in GBP. Hence SGD receipt of distributions or any capital gain/loss will be subject to forex conversion risk.

Parting thoughts

Despite the acquisition exercise in FY2021 of 58 additional UK commercial properties, the so-called "diversification" of tenant base towards other UK Government occupiers beyond the DWP for other tenants to be 10.4% of total gross rental income is immaterial and ultimately, still with the UK government and not exactly the diversification which I have in mind. EC REIT also has 12 months to decide on their strategy and types of usage for the 8 properties that DWP had exercised the break clause. I remain skeptical of having such a high concentration risk of main tenant and will not be investing into EC REIT.

(P.S: There are some folks who seemed very upset with this posting. I just want to point out that this is a free world. If one's view is that it is absolutely safe, then please put in as much cash or even make it into one's 100% concentrated portfolio. The above is just my personal view due to previous bad experiences with REIT tenant making up more than 90% of rental income and the importance of tenant diversification. This is not a recommendation to buy or sell or to talk-down a particular REIT.)