Hey everyone, welcome back to ‘The Dividend Uncle’! Today, we’re diving into Lendlease Global Commercial REIT or LREIT (JYEU.SI), which is extra important to me because I personally hold around $18,000 worth of units in my portfolio.

A few months back, I shared concerns about rising risks surrounding the REIT (see post here), and since then, I’ve been watching it closely to decide whether to sell, hold, or even add to my position. Given these uncertainties, this is a key part of my portfolio that I’m keeping a sharp eye on.

In this post, I’ll walk you through the three major risks that have pressured the REIT’s price, and explain why I believe LREIT could be heading into brighter days.

Before we dive in, I must let you know that this content is for informational and educational purposes only and does not constitute financial advice. The opinions expressed are based on publicly available information and personal analysis, and they are not tailored to your specific financial situation. The REITs and institutions mentioned are cited purely as examples. While I have no affiliations, sponsorships, or financial relationships with any of them, I may personally hold positions in some of the investments discussed. Before making any investment decisions, you are strongly encouraged to consult a licensed financial adviser.

Okay, let’s dive in!

1. Is the Sponsor selling out?

The first big question: is Lendlease, the REIT’s sponsor, jumping ship?

Back in May 2024, Lendlease, which has always been a heavyweight in the construction industry, announced plans to sell off its overseas construction businesses to focus on Australia. This sent shockwaves, and naturally, people began wondering if they’d sell their stake in LREIT as well. The timing wasn’t great, especially since we saw other sponsors like A.R.A. and Cromwell pulling out of their respective REITs.

For many investors, the strength of Lendlease as a sponsor was a key reason for backing the REIT. Lendlease, with its significant 28% stake in the REIT, brought with it a strong REIT management team, and a pipeline of high-quality assets, like J.E.M. mall and Paya Lebar Quarters. If they were to pull out, it would definitely shake investor confidence.

But here’s the good news: things seem to be stabilizing. Lendlease’s share price hit a 7-month high recently, and the sale of their construction business is nearing completion. Plus, there’s been no indication that they’ll sell their stake in LREIT. In fact, Lendlease recently announced a new joint venture with Warburg Pincus in the life sciences real estate space, which is headquartered in Singapore. This is a promising development, showing Lendlease is continuing to expand its business, in non-construction areas.

So, with Lendlease looking stronger now and no signs of them offloading their REIT stake, this risk seems to be fading.

2. High Gearing and Increasing Interest Rate Pressures

Now, onto the second risk: gearing and interest expenses.

The REIT’s gearing ratio is currently quite high at 40.9%. If we take into account the $400m perpetual securities, the gearing ratio is as high as 51.5% (thanks REIT-tirement.com for the charts).

With about 23% of its debt maturing in the next year, the current interest rate of 3.58% is expected to rise. Even though the US Fed has started cutting rates, the renewed rates are likely to push up the average interest rates as they are still way above the original rates. It’s likely that LREIT’s borrowing costs could jump to around 4.5%, according to some analysts. This would continue to put pressure on financing costs and, unfortunately, on the D.P.U. as well.

In fact, we’ve already seen this impact in FY2024, where the D.P.U. dropped 17.7%, largely due to these higher financing costs.

However, management has hinted at a potential solution – the sale of the J.E.M. office space. They’ve already had viewings with 10 prospective buyers, and I think this could be a viable way to reduce gearing. The J.E.M. office is fully leased to the Ministry of National Development until 2044, making it a very stable asset. Under normal circumstances, I’d prefer they hold onto such a gem (pun intended!), but with D.P.U. under pressure, I think a sale here would be a smart move. If the sale goes through, analysts estimate that gearing could be lowered to around 35%, which would ease a lot of pressure.

So while this risk is still present, there’s a clear path forward to address it.

3. Is the ‘Sky’ Falling in Milan? Navigating the Clouds of Leasing Risk

Lastly, we have the leasing uncertainty in Milan.

As part of its IPO assets, the REIT owns three buildings leased to Sky Italia. These account for about 10% of the property value, but provided stability to the income of the REIT as they were fully occupied by Sky Italia, an Italian satellite television platform owned by the American media conglomerate Comcast. Sky Italia broadcasts three national free-to-air television channels.

But it was announced in December 2023 that LREIT has restructured the lease with Sky Italia such that Building 3 will be returned to the REIT. Now, there’s a bit of a silver lining here: LREIT negotiated a rental uplift of 1.2% for Buildings 1 and 2, which are fully leased to Sky Italia until January 2033. So, those two buildings are set, providing stable revenue for the REIT.

The real question is what happens to Building 3. The REIT is in the process of repositioning it for multi-tenancy to attract market rents, and this is definitely the key risk to watch. If they can successfully lease out Building 3 at favorable rates, this risk could be mitigated. But overall, given that the property accounts for one-third of the 10% exposure to Italy, I feel it is a risk that should not be overblown.

The Dividend Uncle’s Take

Now, let’s talk about what I’m doing with Lendlease Global Commercial REIT in my portfolio.

I’ve decided to hold onto my position for now. With the sponsor showing signs of recovery and no news of them selling their stake, I’m feeling more comfortable with the sponsor risk. The potential sale of the J.E.M. office space to reduce gearing is also something I’ll be watching closely. If the sale goes through, it could give LREIT a much-needed breather, which is why I’m not rushing to make any drastic moves.

At the same time, I’m keeping a close eye on the Milan leasing situation. The successful repositioning of Building 3 is crucial for the long-term performance of the REIT, but it’s a small risk I’m willing to accept in the short term, given the stable income from Buildings 1 and 2.

So, for now, I’m holding my investments in LREIT in my portfolio, and watching these developments closely. If things continue to improve, I may consider adding more, but I’m not in a hurry to load up just yet.

To sum up, are we seeing brighter days ahead for LREIT? Well, in my view, two of the major risks, the sponsor sale and the high gearing, are showing signs of easing. There’s a potential path to lower gearing, and the sponsor seems to be on more stable footing. The leasing risk in Milan is still there, but it’s manageable for now.

Let me know in the comments what you think. Are you holding onto Lendlease Global Commercial REIT, or are you staying away until things settle down further?

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