Two weeks ago (May 30), I looked at a unique float – IVF services company Virtus Health, which was the first company of its kind to be listed in the world. As suggested in the article, unsatisfied demand for the stock in the primary issue (through the prospectus) helped Virtus come on to the ASX trading screens at a nice 9% premium, which it has so far maintained.
Today I want to look at another unique initial public offering (IPO), which will probably find the opposite experience when it lists.
It is Domus US Multifamily Real Estate Fund, a real estate investment trust (REIT) that has been formed to invest in multifamily residential real estate in some of the major US markets.
What’s multifamily estate?
Multifamily real estate is an interesting property investment sector that we do not have in Australia. It is any building that contains five or more separate dwellings held on a single legal title and leased to individual tenants. In Australia, the dwellings that make up an apartment building are typically held on individual or “strata” titles with multiple owners.
In the US, a multifamily apartment project can consist of several hundred individual apartments. The sector is very popular with young renters, in the 18 to 35-year-old bracket: ironically, the closest comparison in Australia is probably retirement villages, where there are a lot of individual dwellings on the same title, managed on the residents’ behalf, with communal facilities provided.
Domus US Multifamily Real Estate Fund is looking to raise up to $100 million from Australian investors to buy a portfolio of large-scale multifamily projects – meaning 150-plus apartments – in the southern and western regions of the US. The fund is to be seeded with two multifamily housing complexes bought by Domus for $US60 million in Dallas, Texas, and Albuquerque, New Mexico, with 516 apartments collectively.
The fund is focusing on the southern and western regions because typically they have lower unemployment rates than other regions of the US: there is an on-going trend for individuals and businesses to relocate from the more recession-affected areas of the US, such as the mid-western and north eastern states, to southern and western states, which generally offer a more moderate climate, a lower overall cost of living, and for businesses, less restrictive labour laws.
According to the Domus US Multifamily Real Estate Fund prospectus, since the GFC – and the profound effects it had on the US housing market – there has been a steep decline in the number of owner-occupied dwellings in the US and a corresponding sharp increase in the number of tenant-occupied rental units. The Fund says its prime renter demographic cohort of 18 to 35 year olds is the largest in US history and is forecast to continue to grow, so the long-term fundamentals of future rental demand strongly favour the multifamily sector.
Strong sector
Financially, too, the sector has strong underpinnings. Large-scale multifamily real estate assets are eligible for low fixed-rate, long-term (up to 35 years) non-recourse US Government-insured debt. The fixed rate is set at a spread over the US 10 year Treasury rate: currently this debt carries an interest rate of 2.9%–3.5% a year: Domus’ strategy is to leverage the portfolio using this debt to significantly expand on the size of its portfolio in order to provide higher yields.
As such, Domus says it could prudently carry an overall leverage ratio of about 60%–70%. Although this is well above the Australian REIT sector average – most of the high-quality A-REITs have gearing ratios of 40% or less – the Domus portfolio would not suffer from the short-term loan refinancing risk that Australian REITs have: owners of commercial real estate in Australia are exposed to refinancing risk about every three to five years, at both unknown interest rates and asset valuations.
Also, US Government-insured debt does not carry financial covenants such as loan-to-value ratio covenants, meaning it does not require the borrower to increase its equity in a multifamily asset if the value of that asset falls.
Domus US Multifamily Real Estate Fund intends to pay quarterly distributions in Australian dollar ($A), with the first distribution to be paid in October 2013. At the offer price of $1, the distributions for the first two quarters, to 31 December 2013, are forecast at a minimum of 3.6 cents a unit, which according to the prospectus implies an annualised yield of 6.2%. There is no tax-advantaged component to that yield.
How it’s structured
The fund is structured as an unhedged fund, meaning that if the Australian dollar depreciates against the US dollar, Australian investors potentially benefit in $A terms from increases in the value of the portfolio and the value of US$ dollar distributions.
The asset class is an interesting one for SMSFs, the yield is attractive and the unhedged nature of the cashflows and asset valuations is appealing given that most investors expect the $A to fall against the greenback.
But here is the rub: the IPO’s managers, Bell Potter and Ord Minnett, are having trouble raising the money. Originally the offer was scheduled to close on 31 May, with the units allotted by 7 June and trading on the ASX by 18 June. The book-build has been extended in time twice now, and the raising is now scheduled to close on 5 July.
One factor that might explain this is that when the book-build got underway, the $A was trading at US$1.02 – it is now trading at 94.5 cents. This has spooked investors, while, ironically, demonstrating that entering an unhedged investment at US$1.02 was a good investment in the first place. The same goes for the sensitivity to the US 10-year bond rate.
Bad memories
The market may also have bad memories of overseas REITs such as those run by Rubicon, Valad, Allco, Centro and Babcock & Brown, all of which hit trouble in the GFC. It might be that there is no easy local comparison from which to gauge the fundamentals of the US multifamily apartment block market; it might even be that local investors see the plethora of multifamily apartment REITs trading on the US market and think, ‘why go into a portfolio that is being established, when there are existing portfolios I can invest in?’ – even if this one is listed on their own market in $A. It might be that local investors are not doing their homework properly. It might just be a generally nervous market.
Whatever it is, Bell Potter and Ord Minnett are clearly having trouble selling the stock. Given this weak appetite for Domus, investors who are interested in Domus US Multifamily Real Estate Fund can afford to wait to see (a) whether the IPO goes ahead, and (b) if so, the size of the discount at which they can buy the stock in the after-market.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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- Paul Rickard: Question of the week – is Stockland a buy at these prices?
- Paul Rickard: Questions of the week – dividend payers to hold for the long-term
