New built-to-suit development announced. A-REIT announced that it has secured from SingTel a built-to-suit development project of a 9-storey hi-tech industrial building. The estimated total investment for the building, land and equipment is estimated at S$175.4million and the project is expected to complete by 1Q2010. Upon completion, SingTel will lease the entire building for an initial tenure of 20 years with annual rental escalation, and an option to renew for a further 10 years on expiry.

Fine-tuning our estimates. Upon completion, annual DPU accretion would be about S$0.28cents/unit based on management estimates, and we have therefore raised our DPU estimates from FY11E onwards by about 1.5 -2% p.a. Our FY10 estimate for gearing has also been increased to 38.7% to account for the additional borrowings.

Long-term accretive deal, but cost of equity raised in the short run. Average yield on cost for the entire 20-year period is slightly over 10% according to management, but we estimate that the initial passing yield on cost would be lower at about 6.5%. Although gearing for A-REIT would increase by only 1% as a result of this transaction and the trust has a ready revolving credit facility to draw down, the incremental cost of debt and its implication on cost of equity would be higher than it appears under current credit environment in our view; and we see some short-term share price vulnerability as a result.

We retain our Overweight rating on AREIT, with a reduced Dec-09 price target of S$1.65/unit (S$1.70/unit previously), based on our DDM valuation using 8.5% discount rate (8.2% previously). Key risks to our rating and price target include a worse than expected deterioration in operating fundamentals and a prolonged capital markets downturn leading to elevated costs of capital for A-REIT.