Valuation declines, profits hindered, ESR REIT's reply letter 'arrives fashionably late'
AVIC ESR Warehouse Logistics REIT finally completed its response to the Shanghai Stock Exchange's inquiry letter on April 19.
This came nearly three full months after the inquiry letter was issued. According to the initial requirements of the Shanghai Stock Exchange, AVIC ESR Warehouse Logistics REIT was supposed to respond within 30 working days, with the maximum extension period not exceeding 30 working days.
This "long overdue" response letter once again highlighted the pressures and challenges currently facing the logistics and warehousing industry.
ESR Group (Yishang), coming with sincerity, offered the Fulade Kunshan Logistics Park, which has been stably operating for over a decade, as the underlying asset. However, fierce market competition has also imposed certain operational pressures on it.
Disclosures show that as of March 31, 2024, the overall occupancy rate of the aforementioned infrastructure project had dropped to 79.88%. According to the initial filing data, as of November 1, 2023, the project's overall occupancy rate was 89.49%.
Operational pressures have also affected the project's market valuation. As a result, the proposed issuance scale of AVIC ESR Warehouse Logistics REIT was reduced from the original 2.87 billion yuan to 2.435 billion yuan.
This also reflects, to some extent, the significant difficulty AVIC ESR Warehouse Logistics REIT faces in going public.
Significant Fluctuations in Occupancy Rates
The announcement reveals that the infrastructure projects of AVIC ESR Warehouse Logistics REIT are divided into Phase I, II, and III of Fulade Kunshan Logistics Park, all of which are modern warehousing and logistics facilities (high-standard warehouses), with the planned and actual use being logistics warehouses. Among them, Phase III of Fulade Kunshan Logistics Park was put into operation in February 2018 and is the first four-story, large-span, heavy-load logistics warehouse in East China.
Historical data shows that Fulade Kunshan Logistics Park has maintained relatively stable occupancy performance since its operation, with an average occupancy rate of approximately 94.4% over the past five years.
AVIC ESR Warehouse Logistics REIT also pointed out in its response letter that from 2018 to 2022, the project's average occupancy rate was as high as 98.1%. Particularly from the second half of 2020 to the first half of 2022, the project was nearly fully occupied, with only a small amount of vacant space in the ancillary comprehensive building.
However, entering 2023, due to the combined impact of macroeconomic fluctuations, the concentrated entry of regional logistics projects into the market, and the pressure from concentrated lease expirations and re-leasing, the project's occupancy rate came under pressure.
Disclosures show that the lease expiration area of the project in 2023 reached 336,700 square meters, accounting for 88.2% of the total leasable area, significantly increasing the pressure for re-leasing. Additionally, some tenants withdrew due to adjustments in their business strategies, further affecting the occupancy rate.
This includes a well-known international supermarket chain that strategically exited the Chinese market in the first half of 2023, leading to the withdrawal of approximately 9% of the warehouse's leasable area. Furthermore, two major tenants reduced their leased area after their original contracts expired, also contributing to the decline in the project's occupancy rate.
From the data, the concentrated lease expirations mainly occurred in Phase III of Fulade, which was put into operation in 2018, with most contracts signed for 3-5 years. By the end of 2023, the occupancy rate of Phase III dropped sharply from 96.4% at the end of 2022 to 67.2%. This directly impacted the overall occupancy rate of the logistics park project. Disclosures show that by the end of 2023, the average occupancy rate of Phases I to III was 81.4%.
Currently, the impact of concentrated lease expirations in Phase III on the occupancy rate still requires some time to recover. By the end of March 2024, the occupancy rate of Phase III further dropped to 62.1%, a historical low. Coupled with a decline in the occupancy rate of Phase I, the average occupancy rate of Phases I to III further fell to 79.88%.
However, this downward trend is expected to improve by mid-2024. According to the response letter, as of March 31, 2024, Phase III of Fulade had approximately 41,500 square meters of leases starting from June 1, 2024, with contracts already signed before the start date. After these tenants move in, the occupancy rate of Phase III will increase to 87.44%, and the overall project occupancy rate will rise to 90.6% by June 2024.
Additionally, Phase I of Fulade has signed leases for 6,928.78 square meters starting from July 1, 2024, and 4,439.80 square meters starting from January 1, 2025. Therefore, the appraisal agency expects the project's occupancy rate to gradually increase to 92.1% in years 2-3.
Fluctuations in occupancy rates will inevitably affect the profitability of the logistics park.
Declining Rents and Valuations
To quickly improve the occupancy rate, Fulade Kunshan Logistics Park has implemented a certain degree of rent reduction.
The response letter shows that as of the end of 2023, the average rent of Fulade Kunshan Logistics Park was approximately 1.36 yuan per square meter per day, a year-on-year decrease of 0.7%.
Historical data indicates that from the end of 2018 to the end of 2022, the area-weighted average rent level increased year by year. By the end of 2022, the average rent was approximately 1.37 yuan per square meter per day.
It is worth noting that although the project's rent achieved a compound annual growth rate of 3.06% from 2018 to 2023, the growth rate has been declining year by year. From the end of 2019 to the end of 2023, the average rent growth rates were 4.3%, 4.1%, 3.9%, 3.8%, and -0.7%, respectively.
As of the first quarter of 2024, the rent levels of Phases I to III of Kunshan Fulade ranged from approximately 1.23 to 1.43 yuan per square meter per day. The rent levels of three comparable projects in the surrounding area were 1.36 yuan, 1.33 yuan, and 1.41 yuan per square meter per day, respectively.
Although AVIC ESR Warehouse Logistics REIT has revealed that as of the end of March 2024, leases with a rent growth rate of 4% accounted for 85.26% of the leased area (excluding leases with terms of one year or less), and all new leases signed in the past year (excluding leases with terms of one year or less) had a rent growth rate of 4%, the market remains skeptical about whether it can sustain this 4% growth rate due to the combined impact of new supply and rent reductions in the surrounding area.
In fact, out of caution, AVIC ESR Warehouse Logistics REIT also revised the relevant figures in its response letter, lowering the project's future ten-year compound growth rate to 2.97% and the long-term growth rate to 2.75%.
The decline in rents undoubtedly leads to reduced revenue, further affecting the project's asset valuation. According to the response letter, as of the end of March 2024, the valuations of Phases I, II, and III had decreased from the original 1.018 billion yuan, 603 million yuan, and 1.249 billion yuan to 866 million yuan, 507 million yuan, and 1.062 billion yuan, respectively. The overall valuation of the underlying asset project, as of March 31, 2024, was 2.435 billion yuan.
Consequently, the valuation of AVIC ESR Warehouse Logistics REIT was also adjusted downward by 435 million yuan, from the initially disclosed 2.87 billion yuan to 2.435 billion yuan.
It is also noteworthy that the project's rent collection rate has declined to some extent.
Disclosures show that from 2020 to 2022, the project's rent collection rate was 100%; by 2023, it had dropped to 99.57%; and from January to March 2024, it further declined to 88.19%.
AVIC ESR Warehouse Logistics REIT explained that the lower rent collection rate from January to March 2024 was mainly due to one of the key cash flow providers delaying payments because of internal approval processes, with the actual payment date being later than the statistical cutoff date. As of the date of the response letter, the operating management agency had obtained email confirmation from the tenant that the payment would be made by the end of April. After this payment, the rent collection rate for January to March 2024 would reach 96.54%.
AVIC ESR Warehouse Logistics REIT further clarified that the rent collection rates for 2023 and January to March 2024 not reaching 100% did not mean the remaining amounts were unrecoverable or would result in bad debt losses. Rather, at the statistical cutoff date, some tenants had not paid on time, leading to delayed payments. During the reporting period, there were no instances of bad debt losses for the infrastructure project.
Although no bad debt losses were incurred, delayed rent collections by some tenants could still cause fluctuations in the net operating cash flow of the infrastructure project, adversely affecting the returns for fund holders.
Negative Performance Risks and ESR's "Safety Net"
According to the response letter, from 2021 to 2023 and the first quarter of 2024, Jiangsu Fulade's operating revenues were 172 million yuan, 174 million yuan, 151 million yuan, and 40 million yuan, respectively. Operating revenues mainly consisted of rental income and property management income.
From 2021 to 2023 and the first quarter of 2024, Jiangsu Fulade's gross profits were 116 million yuan, 119 million yuan, 95 million yuan, and 26 million yuan, with gross profit margins of 67.29%, 68.42%, 62.91%, and 65.31%, respectively. By the end of 2023, Jiangsu Fulade's gross profit had slightly declined, mainly due to reduced rental income.
From 2021 to 2023 and the first quarter of 2024, Jiangsu Fulade's adjusted operating net income was 148.087 million yuan, 153.4058 million yuan, 127.683 million yuan, and 34.0592 million yuan, respectively.
Compared to 2021, Jiangsu Fulade's adjusted operating net income increased in 2022. However, in 2023, it declined compared to 2022, mainly due to the combined impact of concentrated lease expirations and some tenants adjusting their business strategies, leading to a drop in the project's occupancy rate in 2023.
Although the project has successfully leased most of the vacant space, given the 3-5 year lease terms common in the warehousing industry and the still fluctuating economic recovery, the project still faces some re-leasing pressure.
As of the end of March 2024, among the executed leases, leases with terms of two years or less accounted for 114,100 square meters (37.37%), while leases with terms of three years or more accounted for 146,700 square meters (48.01%).
Additionally, as of the end of March 2024, the lease expiration areas for April to December 2024, 2025, and 2026 accounted for 4.65%, 40.05%, and 39.73% of the leased area, respectively. It is reported that the current operator has already initiated communication with tenants for lease renewals and re-leasing arrangements to address the vacancy risks during the re-leasing period.
The fund's net operating cash flow is also inevitably affected. Data shows that from 2021 to 2023 and the first quarter of 2024, Jiangsu Fulade's net operating cash flow was 147 million yuan, 116 million yuan, 116 million yuan, and 25 million yuan, respectively.
Meanwhile, the fund has also adjusted the project's distributable amount. According to the initial filing data, the fund's projected distributable amounts for the next two years starting from 2024 were both 130 million yuan, with annualized cash flow distribution rates of 4.4% and 4.5%, respectively.
The response letter updated these figures to: 54.793 million yuan from July 1, 2024, to the end of 2024, and 113 million yuan for 2025, with annualized cash flow distribution rates of 2.25% (annualized 4.5) and 4.62%, respectively.
This has somewhat affected investors' confidence in the performance of AVIC ESR Warehouse Logistics REIT after its listing. It is reported that to incentivize the operating management agency to ensure smooth re-leasing and stable post-listing prices, ESR Group (Yishang) has stipulated in the operating management agreement that over the next three years, if the project's operating revenue is negatively impacted, ESR Group (Yishang), as the operator, will take measures to mitigate these negative effects.
Whether ESR Group (Yishang)'s "safety net" can effectively alleviate investors' concerns about potential risks remains to be seen.
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