Valuation cut by 80 million, why did Capital Outlets REIT 'lower its value'?

On April 25, ChinaAMC First Outlet REIT officially responded to the inquiry letter from the Shanghai Stock Exchange, and the project status was updated to "Feedback Received." This brings it one step closer to listing. If everything goes smoothly, ChinaAMC First Outlet REIT is expected to become China's first Outlet REIT and the fifth consumer public REIT.

Data shows that the underlying assets of ChinaAMC First Outlet REIT are the Jinan First Outlet project and the Wuhan First Outlet project, with a total construction area of 203,600 square meters. Beijing Capital Commercial Management Co., Ltd. is the issuer of the bond, and ChinaAMC is the underwriter.

In the inquiry letter issued by the Shanghai Stock Exchange in February, concerns were raised about the business model of the Outlet projects and the excessively high and rapid valuation parameters of the fund. In the response letter, ChinaAMC First Outlet REIT addressed these issues one by one. At the same time, the REIT also adjusted the project valuation, directly reducing it by 80 million yuan to 1.973 billion yuan. This reflects the current pressure on REIT issuance.

Sales Conversion Improvement is the Operational Challenge

To ensure the smooth issuance of the REIT, Capital Group has brought its best projects to the market. In terms of sales and revenue, the Jinan and Wuhan First Outlet projects rank among the top three in the Capital Outlet system.

According to reports, the Jinan First Outlet project opened in 2019 and has been operating for five years. Since its opening, the project's sales have ranked first in the Jinan Outlet market for five consecutive years, with a market share exceeding 55% in the past three years. The project's revenue has continued to grow, with a compound annual growth rate of 26.97% from 2021 to 2023.

The Wuhan First Outlet project opened in 2018. Over the past five years, its sales have consistently led the Outlet market in the area south of the Yangtze River in Wuhan, with a market share of around 50% in the past three years and over 25% in the Wuhan Outlet market. The project's revenue has also grown steadily, with a compound annual growth rate of 22.93% from 2021 to 2023.

It is worth noting that the Jinan and Wuhan First Outlet projects are positioned as premium outlets, featuring a "high-value model" with "brands + discounts + experiences." They host over 200 brand merchants, more than 80% of which are international and domestic retail brands.

Although Outlets are also categorized as "shopping centers," their business model differs significantly from traditional shopping centers. In the previous inquiry letter, the Shanghai Stock Exchange raised questions about the similarities and differences between Outlets and shopping centers, as well as the specifics of their leasing models.

Outlets in the retail industry specifically refer to shopping centers composed of stores selling off-season, discontinued, or out-of-stock branded goods, also known as "brand direct shopping centers." Their leasing models primarily include joint operations and revenue-sharing, with fixed rents as a supplementary option. Joint operations apply to most merchants (e.g., sports and outdoor gear, international brands, apparel), while revenue-sharing is typically used for retail categories with special operational requirements (e.g., gold and jewelry, cosmetics). Fixed rents are applied to Chinese restaurants and convenience stores.

Therefore, in terms of revenue composition, while Outlet projects include rental income, property management fees, promotional fees, and other income, their rental income is primarily derived from joint operations and revenue-sharing. Joint operation income is calculated as merchant sales multiplied by the contract rate and is classified as rental income in financial accounting. For example, in the Jinan and Wuhan First Outlet projects, joint operation and revenue-sharing income accounted for over 90% of rental income in the past three years.

Under this risk-sharing model, fluctuations in merchant sales performance can significantly impact the project company's income.

Additionally, since the specific calculation of related income is based on merchant sales multiplied by the contract rate, merchant sales and contract rates can be affected by economic conditions, regional competition, category competition, public health events, operational efficiency, and project development stages. These factors may lead to income volatility, potentially adversely affecting fund distributions.

How to improve sales conversion and stabilize occupancy rates to generate sustainable income has become the biggest challenge for Outlet projects.

Risk-Sharing Joint Operation Model

To further enhance sales conversion, the Jinan and Wuhan First Outlet projects have been actively upgrading brands and optimizing their structures in recent years.

For instance, the Jinan First Outlet project focused on introducing gold and jewelry brands in 2021, creating a dedicated area for them. In 2023, during the project's first major adjustment period, 87.25% of brands renewed their contracts, and 27 new brands were introduced. To align with current consumer preferences, seven domestic trendy brands were added. The project also adjusted its dining layout (moving to less popular areas) and introduced sports brands in the original dining areas, increasing the retail space for sports and leisure categories to enhance the project's appeal.

It was revealed that 109 brands in the Jinan First Outlet project will have contracts expiring in 2024. The project has already made renewal arrangements, with an expected overall renewal rate of 80%-85% and proactive replacements of 15%-20%. So far, eight new brands have been confirmed, with over ten more in negotiation.

From January to March 2024, the project had 6,384.53 square meters of expiring leases. As of now, 5,807.66 square meters have been renewed or newly leased, accounting for 90.96% of the expiring area, with the renewal/new lease rate reaching 100%.

As for the Wuhan First Outlet project, 2021 marked its first major contract expiration period, during which 57% of brands renewed their contracts, and over 40 new brands were introduced to replace underperforming ones. In 2023, the second major expiration period saw 77% of brands renewing, with over 20 new brands introduced. In 2024, 73 brands will have contracts expiring, with renewal arrangements already in place. The expected renewal rate is 80%-85%, with proactive replacements of 15%-20%. So far, three new brands have been confirmed, with over ten more in negotiation. From January to March 2024, the project had 2,176.8 square meters of expiring leases, with 2,032.80 square meters already renewed or newly leased, accounting for 93.38% of the expiring area, and the renewal/new lease rate reaching 100%.

Additionally, ChinaAMC First Outlet REIT noted that under the joint operation model, merchant performance directly impacts the Outlet operator's income, creating a deep interdependence. This requires the Outlet operator to actively engage in merchant operations and collaborate more efficiently.

For example, in daily operations, the operator may delve into merchant inventory management, personnel management, sales management, pricing, marketing, and after-sales service. This includes providing guidance to new merchants and offering support to struggling ones, such as marketing and member referrals. For brands with low sales per square foot, significant year-on-year declines, or performance far below regional averages, the operator will closely monitor them. If performance does not improve after discussions and support, the operator may adjust their locations or terminate contracts upon expiration to ensure project profitability.

In terms of occupancy rates, this 良性互动 has yielded positive results. The Jinan First Outlet project's occupancy rate has steadily increased over the past three years, reaching 92.1% by the end of 2023. Currently, a major tenant is expanding, with completion expected in May. The expansion will cover 1.8% of the leasable area, bringing the occupancy rate to 94%. The Wuhan First Outlet project has maintained an occupancy rate above 94.5% for the past three years, reaching 96.8% by the end of 2023.

Asset Valuation Adjusted Down by 80 Million

In terms of operational data, the Jinan and Wuhan First Outlet projects have delivered impressive performance in recent years. Under the joint operation model, their historical contract rates have shown rapid growth.

Disclosures show that the Jinan First Outlet project's average joint operation rate increased from 6.8% in 2020 to 10% in 2023, while the Wuhan project's rate rose from 8.6% to 10.7% over the same period.

The new property management fee income for the projects also saw significant growth. In 2023, the Jinan and Wuhan projects' new lease contracts (including renewals and replacements) had property management fees of 40 yuan/square meter/month and 35 yuan/square meter/month, respectively.

As contracts expired and adjustments were made, the average annual property management fees for the Jinan and Wuhan projects increased from 25 yuan/square meter/month and 24 yuan/square meter/month in 2022 to 30 yuan/square meter/month and 27 yuan/square meter/month in 2023, driving higher year-on-year growth in property management income.

Despite strong operational performance, ChinaAMC First Outlet REIT adjusted some valuation parameters based on regional economic conditions and market competition.

The non-fixed rental sales growth rate forecasts for both projects were lowered. Previously, the 2024 growth rate was projected at 4% for both projects but has now been adjusted to 3%. The 2025 figures were also adjusted to 3%. The long-term net income growth rate beyond the forecast period was reduced from 2.25% to 2%.

Additionally, the Jinan project's discount rate was raised from 8% to 8.25%. The higher discount rate reflects market perceptions of overvalued assets.

As a result, the underlying asset valuations of ChinaAMC First Outlet REIT were adjusted downward.

In the initial prospectus, the Jinan and Wuhan projects were valued at 996 million yuan and 1.057 billion yuan, respectively (as of June 30, 2023). In the latest response letter, these valuations were adjusted to 962 million yuan and 1.011 billion yuan (as of December 31, 2023). This means the REIT's total valuation decreased from 2.053 billion yuan to 1.973 billion yuan, naturally reducing the fundraising scale.

ChinaAMC First Outlet REIT is not the first to experience a valuation adjustment. Analysts suggest that the reduction may be a strategic response to issuance pressures, which could dampen the enthusiasm of original rights holders or sponsors.

However, there are two sides to every coin. "The downward adjustment in REIT asset valuations also releases some intrinsic value, highlighting the investment potential of projects. For investors, it narrows the risk of operational downturns and provides a safer cushion," said one analyst.

The market also noted that primary market valuation adjustments create secondary market opportunities, fostering a multi-tiered and 良性循环 market. This benefits both primary and secondary investors with long-term returns, encourages diverse participation, and reflects regulatory support for the emerging REIT market.