Croesus Retail Trust: Cap rates and growth.

When we invest in a company, it is important to be forward looking. After all, we are investing for the future and not the past. So, although numbers could tell us about the past and the status quo, to forecast performance is a little more difficult.

However, if there is some consistency, then, there could be some measure of predictability. This is probably one reason why many like investing in real estate because their values and rental rates are sticky in the short or even medium term.

Related to this, we often hear people talking about cap rates and some readers have asked me before what exactly are these. Well, cap rate is short for capitalisation rate.

Basically, it is a property's net income as a percentage of its purchase price. So, it is a measure of investment yield. This yield is part of the total return on our investment.

Net income? Yes, you might have seen the acronym NPI before and this stands for Net Property Income. It is basically gross income less expenses. Looking at NPI is more meaningful than looking at gross income, for obvious reasons.

Naturally, we would want to have as high a cap rate as possible if we were to buy a property as investors. This would mean getting as high a net income as possible and/or as low a purchase price as possible.

In a recent interview with Croesus Retail Trust's CEO, he said that it is getting harder to buy real estate in Japan at a bargain as prices have been rising. He also said that the Trust has to move at a faster clip in acquiring another asset.

Clearly, rising property prices will reduce cap rates, all else remaining equal. However, as economic conditions improve and with initial evidence of rising rental rates in the midst of falling vacancy, property prices are more likely to rise than to fall. Expectations are that net income will improve.

So, do I think that Croesus Retail Trust will be delivering a higher distribution yield over the next 12 months? With positive rental reversions at Mallage Shobu expected, everything else remaining equal, yes.

I also suspect that Croesus Retail Trust will be announcing an acquisition soon because:

1. They extended until 31 March 2014 their first right to negotiate for the purchase of the following properties: Mallage Saga, Forecast Kyoto Kawaramachi, NIS Wave I and Luz Omori.

2. They issued a S$100 million MTN last month.

The question is which property would the Trust buy?

Although Croesus Retail Trust is smallish in size given that its initial portfolio of 4 properties has a valuation of JPY 52.5 billion or about S$669 million in total, what can they buy with only S$100 million from the MTN?

Of the four properties in its current portfolio, there are two properties which are closer to S$100 million in valuation:

1. AEON Town Suzuka: S$ 112 million
2. Luz Shinsaibashi: S$ 119 million

Very likely, the Trust's next purchase will be similar in value to these two based on the size of the MTN issued. Of the four properties for which their rights of first refusal (ROFR) have been extended, I wonder which one would it be. Whichever property the Trust decides to buy, however, a completed and mature mall will probably be a DPU accretive acquisition.

Having said this, if each of the four malls on the acquisition list has a valuation of more than S$100 million, then, we might see a private placement taking place. If this should happen, we might or might not see any DPU accretion.

If the Trust should want to purchase two or more malls at once, then, I believe we could see a rights issue. Of course, that would allow all existing unit holders to participate and if the assets to be purchased have attractive cap rates, it should be a good thing.

I hope the management of Croesus Retail Trust does not disappoint. Setting a positive tone in the early years of the Trust's operation will boost investors' confidence and the Trust's standing.

Related post:
Croesus Retail Trust: Substantial shareholders are buying.