REIT Long Lease Rental Issue – Dispute of Agreements: Cache Logistics Trust Case Study

Many investors favor investing in real estate investment trusts (REIT) with strategic properties that tie in tenants on long leases.

There is certainly an appeal:

1. Good Counterparty – You lock in someone who has the ability to pay good rent for a long time
2. Reduces the risk to consistently source for tenants
3. Longer term lease (5 to 10 years) tend to have build in CPI or inflation escalation
4. If its a large component of your portfolio, this tenant drives earnings

However, there are also complications that we might not be aware of.

Cache Logistics Trust, which is an industrial REIT (dividend yield 8.6%) is currently embroiled in a legal dispute with C&P Land, their master lease tenant and Schenker, the main tenant of their master lessor on their warehouse in Airport Logistics Hub.

As an investor, it is good to follow the SGX > Announcements section, to review the list of events.

Let me try to translate the series of events in more layman terms:

1. There was a lease agreement between C&P Land the Master Lease Tenant with Schenker, an international supply logistics operator prior to Cache Logistics IPO in 2005
2. In this lease agreement (ALA = Anchor Lease Agreement),  Schenker alluded that there is an agreement that they have an option to renew the lease at this warehouse at a pre-agreed rent rate for another 5 years
3. In May, Schenker submitted to JTC and Cache to uphold this agreement. This means Schenker intends to stay, just that they want the rent to be at the pre-agreement level.
4. Cache Logistics, for their part, do not acknowledge that they are aware that there is this agreement in place.
5. Since the master lease with C&P Land is terminated (no more master lease), if Schenker were to stay, Cache Logistics wants the rent to be at market rate
6. At this point, we should point out that this means the pre-agreed rate between C&P Land and Schenker is much below market rate.
7. The master lease with C&P Land expired in Aug 2016 this year, and C&P Limited failed to deliver an empty property to Cache Log. Cache intends to claim against C&P Land for double the rent payable for the time Schenker remains in this property as a result of them not being able to rent out to other potential clients.

The implication to Cache Logistics Trust, and its shareholders is:

• No rental cash flow is coming in from this property (for this duration that Schenker fails to vacate)
• This will affect the cash flow available for distribution to shareholders
• This Schenker Megahub contributed 8-9% of last year (2015) rental revenue
• The legal proceedings will take some time to work itself out
• Should Cache win the legal proceedings, they could have a windfall of double the rent payable

C&P Land, ARA-CWT and CWT – Watching out for their own Personal Interests

This case study is made interesting by the complex relationship between the REIT manager of Cache Logistics Trust, ARA-CWT.

From what we understand this is a joint venture between ARA Asset Management (dividend yield around 3-4%) and CWT.

What I believe is that C&P Land is affiliated to C&P Holdings, the holding company that owns Cache Logistics Trust, and CWT as well.

During IPO, we might be sold a very good case that due to the close working relationship since everything is affiliate with CWT, there will be a lot of complementary synergies.

This legal dispute puts things in a negative perspective.

What I found here is that this situation is similar to Sabana (dividend yield 9.4%).

Sabana at IPO took in the properties from former Freight Links, now called Vibrant Group. In 2015, the ‘sponsors’ and anchor tenants agreed to renew the master leases for 1 year at negative revisions.

We might be under the illusion that things will work out for us shareholders, but real business works in a different way. Everyone is watching out for themselves.

We can infer that this very attractive terms to Schenker was one reason why they signed on, and you have to feel for them, if there really was an agreement.

However, could this be the case of attracting a prospective client regardless of the cost?

The lesson learn is that we should firstly be skeptical that sponsors are likely to dump assets to REITs, as an attractive proposition to realize a relatively big sum of cash and to deleveraged.

Whether they do see themselves as a long term partner with the REIT, we have to assess closely in future actions they take.

This is why I listed management (and perhaps in this case their close relationship with sponsors) as one of the main considerations when evaluating a prospective REIT for buy and hold (Read The 3 High Level Metrics when Picking REITs to Purchase for Buy and Hold or Speculation)

Beware of Last Rental Rate Running Past Market Rent Rate

Long leases are good.

However, when the lease ends, it is where things might become uncertain.

Market rents do fluctuate, and for long lease property, their annual constant rental escalation might bring the last rental rate to be higher than the market rent.

If you are a tenant, would you renew at a higher rate or look for a market rate?

This would depend.

Strategic and Differentiate Assets has its Good and Bad

In some cases, perhaps like Schenker, this property is unique in that it helps their business, and its of a very good location, thus they would want to stay.

If the industrial and commercial properties are commodities and undifferentiated, tenants are likely to go away.

Master Lease will be turned into multi-tenanted.

For some properties, fluctuations in demand and supply might mean it will become difficult to rent out.

An Australian Asset REIT that I owned, Frasers Logistics & Industrial Trust, might be in this situation with their current rent rate higher than the market rate.

Overall REIT Dividend Yield Fluctuates

The dividend payout depends on the net distributable income available.

And that in turn depends on the occupancy of the REIT and average rental rates.

As investors, do not assume dividend yield will go one way: Up.

The buy and rent markets go through its own cycles and we all need to be aware of that.

The future dividend yield of Cache

Many analysts have build in a 8-10% decrease in rental revenue, and its effect on DPU.

It is how we should evaluate the value opportunity to purchase.

My DPU estimation for next year is 8 cents, but some analyst have forecast a 1.89 cents quarterly DPU which comes up to 7.56 cents.

Of course the value of the REIT is not just in the dividends:

1. Cache owns much under 30 years land lease properties
2. Large composition of their properties have turned multi tenanted
3. Next year will have much warehouse supply coming online

What is your perspective of Long Lease properties? Did you learn a different lesson here?

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