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GZI Real Estate Investment Trust (405，HK) REITs benefit from assets injection,Chinese capital background

Tuesday, March 25, 2008

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GZI Real Estate Investment Trust(405)

Recommendation on 25 March 2008
Recommendation	Buy
Price on Recommendation Date	$2.930
Target Price	$3.570

Weekly Special - 9618 JD.com

Summary

GZI Real Estate Investment Trust(GZI REIT) was officially listed in Hong Kong Exchange on December 21, 2005, it is the first purely Chinese capital funded REIT. After listed, through the four commercial properties in core areas of Guangzhou, GZI REIT provides the investors with stable and sustained returns. On January 2008, GZI REIT announced acquisition from parent company Guangzhou Investment Company Limited (GZI). Through the acquisition, GZI REIT acquired Guangzhou Yuexiu Neo Metropolis Plazas around 72.3% equity, converted into HK$ 677 million. We are optimistic on the positive effect from expansion to the shareholders, and give GZI REIT Buy rate, 12-month target price at HK$3.57, 20.6% higher than current price.

Potential performance driving force - property acquisition

This acquisition concerned Guangzhou Yuexiu Neo Metropolis Plaza is located in Yuexiu District, Guangzhou, and a complex property with the functionalities of shopping mall, office building, clubs and car parks, with total areas and rentable areas respectively are 62,000 sq.m. and 49,900 sq.m.. GZI REIT will pay HK$ 677.3 million for the transaction, with price per sq.m. at HK$ 10,931.Specific methods of payment are as follows:

1. As to approximately HK$ 203.2 million by way of issuing units trust at HK$ 3.08 per unit.

2.As to the remaining HK$ 474.1 million thereof by way of payment in cash, and the management team planed to finance through the issuance of convertible bond.

Table 1: GZI REIT Assets Changes Prior and After Acquisition

Data Source：Companys Announcement

Upon completion of the property acquisition, the property area for REITs property portfolio will increase from 160,000 sq.m to 210,000 sq.m., with an increase of 31%.The acquisition price for Neo Metropolis, HK$ 10,931 per sq.m., basically reflects the standard price for the complex properties in Yuexiu District. Calculated on the basis of peripheral properties rent, the annual net rent return rate will be about 5.8%. With prime location and relatively short accomplish time, the occupancy rate and rent both have more room to rise. At the end of 2008, the occupancy rate is hopefully to increase from 75.1% in October 2007 to 98%.By then, GZI REITs dividend rate per share may increase by 4.5% in 2008.

The major shareholders of GZI REITs will successively inject assets from 2008.As early as the beginning of the listing, REITs acquired the prior acquisition right, which is GZI REITs has the priority to purchase the four commercial properties of its major shareholder after listed and the floor areas for these four buildings total 750,000 sq.m. See the table below. Among the four properties that GZI REITs has acquisition right to purchase, Yuexiu Neo Metropolis and Victory Plaza West Tower has accomplished and started leasing, while the Asia Pacific Century Plaza West Tower and Zhujiang New City West Tower is expected to be completed before the opening of Guangzhou Asian Games.

Table 2: Major shareholder committed injecting assets portfolio

Data Source： Companys Listing Information

Smooth performance growth in 2007

Figure 1：Guangzhou Office Building Rent and Vacancy Rate Trend

Source: DTZ Research

The performance of GZI REIT will have grown smoothly in 2007. With respect to occupancy rate, even there are more than 40% areas expiry of the tenancy for Fortune Plaza and City Development Plaza, while renewable situations are optimistic, and nearly realized full rent. However, major clients withdrawing from Victory Plazas podium, meanwhile taking the rental recruitment cycle into consideration, we think the overall occupancy rate will be affected in certain degrees. Anticipated that the whole occupancy rate in 2007 would not exceed 98%, lower than that of 2006.On the aspect of rent, the rent level for commercial buildings in Guangzhou maintained a steady rise momentum, Figure 1. Taking into account rent increases and lease expiry ratio, we forecast the overall rent level will increase about 8%.As property valuation, we expect the property value in 2007 will rise by 6% year-on-year. The expected property income for GZI REIT in 2007 will be about HK$ 376 million, with distributable income reaches to HK$ 231 million, an increase of 11.5% year-on-year.

Figure 2：Property Portfolio GFA and Income Proportion

Source: Companys Interim Report in 2007

Figure 3：Property Portfolio Unit Rent Changes（RMB Yuan/M2/Day）

Source: Phillip Securities

Risk

Inflation. Currently, China Mainlands inflation keeps at a high level, CPI for FEB 2008 is as high as 8.7%.The continually increase inflation may reduce the actual rate of return for REITs in the same pace, and weaken the investment confidence of shareholders, resulting in underselling. Such systematic risk is worth paying close attention.

Macro-control on real estate. In order to maintain the healthy and orderly development of the real estate industry, the Central Government continually has macro-control on it. Despite the introduced major policies are mainly for real estate development industry, but the control and regulation on financial and credit will inevitably play a very restricted role on the REITs development, and therefore there are potential risks.

Valuation

We calculated that in the next 12 months, GZI REITs NAV per share will be HK$ 4.2 (considered factors of acquisition assets).Taking into account the asset quality, macro-control, inflation and other factors, we believe that GZI REITs property income and the size of the trust do not have competitive advantages, we gave a 15% discount, 12-month target price at HK$ 3.57, representing a 21.84% premium increase than current price. We give GZI REIT Buy rate.

Financial Data

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