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Starhill Reit - New Master Tenancy Agreements & Asset Enhancement Initiatives For Starhill Gallery

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Starhill Reit announces two news today which I have earlier anticipated after management hinted at the need for an AEI on their Malaysia properties.

The first is the renewal of the Master Tenancy Agreements for both the Malaysian properties - Starhill Gallery and Lot 10 Property.

The 2 properties were acquired in 2010 and were leased for 9 years to master tenant, Katagreen Development Sdn Bhd, an indirect wholly-owned subsidiary of YTL Corporation Berhad, which is the sponsor for Starhill Reit.

The tenancy agreement expire is in 2019 this year.

The new master tenancy agreement includes a long tenures of 19.5 years for the Starhill Gallery and 9 years for the Lot 10 Property, with a rental step-ups every 3 years from the 4th year till lease expiry.

This represents an annual weighted average increase of about 1.5% per annum if we spread it across.

The new WALE will improve from 5.7 years and 4.2 years respectively to 9.8 years and 6.4 years.

This will provide the much needed stability over the next course of years to come.

The above agreement is contingent upon the Asset Enhancement Initiatives (AEI) works required to be done on their Starhill Gallery, which includes conversion of integrated development on their retail and hotel concept of the upper three floors to develop it into hotel rooms.

The AEI works will take approximately 2 years to complete at an approximate costs of RM 175m (SGD 58m) and will be borne by Starhill Reit.

This is not a very big amount spread across the 2 years and Starhill is funding this via debt, which will increase their gearing post AEI works from 35.5% to 36.7%.

I was initially worried about the loss of income during the AEI but turns out the management will bear the disruption during this period via a rental income support and partial payment in management units.

The rent rebates will be given 6 months per year during the AEI period to mitigate the disruption, which works out to be around RM 26m per annum. Management has cited that rent rebates will continue to be given should there be delay in AEI works beyond the 2 years.

Pro-forma pre and post AEI works DPU, including taking the new master agreement is expected to remain at 4.55 cents, so the IRR looks to be offsetting one another with the lease agreement.

Overall, what investors get is a slightly higher gearing, a newer asset building and renovation and a longer lease expiry profile. 

I was initially expecting a better IRR return with a slightly lesser WALE but in all I think it works out better in our favor for longer term investors.

At the current share price of 70 cents, this works out to be 6.5% yield.

Thanks for reading.

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