Keppel-KBS US REIT - DBS Research 2018-01-15: Bright Spark In US Office Revival

Keppel-KBS US REIT - DBS Vickers 2018-01-15: Bright Spark In US Office Revival KEPPEL-KBS US REIT CMOU.SI

Keppel-KBS US REIT - Bright Spark In US Office Revival

  • Exposure to attractive office real estate fundamentals supported by sustainable US economic growth
  • Robust growth outlook underpinned by in-built rental escalations and rental reversion opportunities
  • Strong Sponsors in the form of Keppel Capital and KBS.
  • Initiating coverage for Keppel-KBS US REIT (KORE) with BUY rating and Target Price of US$0.95. 


A diversified portfolio with strong property attributes 

Well-diversified exposure in rising US office market. 

  • Keppel-KBS US REIT (KORE) offers investors a unique opportunity to invest in a quality portfolio of office assets in the US, one of the largest economies in the world. Each property within the portfolio is located in key regional markets that are seeing positive market dynamics.
  • The initial portfolio comprises 11 properties diversified across eight markets across the East, Central and West Coast. The initial portfolio has a net leasable area (NLA) of 3.2m square feet (sqft) worth an appraised value of US$829.4m, based on the higher of two independent valuations. 
  • In terms of value, the portfolio is weighted towards the markets of Seattle (45%), Denver (15%), Houston (16%) and Austin (9%), which in aggregate forms close to 85% of total portfolio value. The remaining 15% is split between the markets of Atlanta (5%), Sacramento (5%) and Orlando (5%). In terms of value, the largest property is The Plaza Buildings (29%), followed by Bellevue Technology Center (16%), Westmoor Center (15%), 1800 West Loop south (10%) and West Loop I & II (6%). These five properties contribute close to 76% of the overall portfolio’s appraised value.
  • In terms of revenues, the initial portfolio will derive an estimated c.76% of revenue from the markets of Seattle (34%), Denver (21%), Houston (15%) and Austin (11%). Six of the 11 properties also contribute close to 70% of revenues and they are, The Plaza Buildings (22%), Westmoor Center (15%), Bellevue Technology Center (12%), 1800 West Loop I & II (12%) and West Loop I & II (9%). 
  • In addition, approximately 32% of the portfolio by Cash Rental Income is located in Class A buildings in CBD locations, 37% in Class A Suburban buildings and 31% of Class B+/B Suburban properties.

Diversified Tenant base 

Strong tenant base with a good diversity in trade sectors.

  • Keppel-KBS US REIT (KORE)’s properties enjoy good tenant demand and serve a well-diversified group of tenants. The top 10 tenants contributed only c.22.3% of cash rental income as of 30 June 2017, out of a total tenant base of 340 across the initial portfolio.
  • Top tenants include Zimmer Biomet Spine, Inc (3.0% of cash rental income for the month of June 2017), Unigard Insurance Company (2.7%), ServiceLink Field Service LLC (2.3%), Ball Aerospace & Tech Corp (2.2%), US Bank National Association (2.2%) and Oracle America, Inc (2.1%). A majority of leases are signed on a long-term basis with an average WALE of 5.2 years for the top 10 tenants, longer than the portfolio WALE of 3.7 years.

Significant exposure in growth and defensive sectors. 

  • We note a majority of tenant base are companies in either growth or defensive sectors which, according to Cushman and Wakefield, are seeing strong employment growth.
  • In terms of cash rental income for the month of June 2017, tenant base composition is broken down into Professional Services (35% of cash rental income as of 30 June 2017), Finance and Insurance (29%), Technology (16%), Medical and Healthcare (6%), Media and information (6%) and Others (8%). The diversified tenant profile means that the portfolio is not totally dependent on the performance and outlook of any particular tenant sector.

Riding on the wave of US economic recovery 

A portfolio located in key markets in the US; whose real estate market have positive market dynamics. 

  • We are excited about the unique attributes that Keppel-KBS US REIT (KORE) offers to investors. Offering exposure to one of the world’s leading economies, the REIT is poised to benefit from the recovery of the US economy and having properties in key markets which have favourable demand and supply dynamics.

US economic recovery is outpacing major developed economies in the West. 

  • The US economy is one of the fastestgrowing economies among developed countries in the West, according to Cushman & Wakefield. Looking ahead, the US economy is expected to continue growing strongly, with an estimated GDP growth of 2.2%, higher than its historical growth rate of 1.5%. Unemployment rates are also expected to be on the downtrend from the 4.4% level as the current labour participation rates of 63% as of March 2017 remains below an optimal level.
  • In our view, KORE should do well, as a majority of its properties are located in markets where the projected GDP growth of 2.6-5.8% per annum exceed the national average of 2.0%.

Positive macroeconomic indicators point towards stronger office demand. 

  • With macroeconomic indicators turning positive, we believe it will have positive implications for real estate demand going forward and the office sector will be a prime beneficiary. This is because as business activity and confidence pick up, the expected expansion of businesses should translate to higher office space demand. 
  • According to Cushman & Wakefield, the recovery in the office employment outlook will be led by the professional and business services sector. In addition, in recent times, we have seen growing demand for office space within the fast-growing technology sector – both from the start-ups and rapid expansion of technology leaders such as Facebook, Amazon and Oracle.
  • Moreover, supply has been somewhat constricted. According to Cushman & Wakefield, developers have generally exercised caution in new constructions. This, combined with healthy demand, should lead to a general decline in the national vacancy rate in the coming years as new completions lag absorption. This is likely to be supported by rents and occupancy rates going forward.

Properties located in markets with improving market dynamics 

Strategically located in key business markets in the US. 

  • Keppel-KBS US REIT (KORE)’s initial portfolio is strategically located across key business centres in the US which have seen positive job creation and population growth which are higher than the national average. In our view, this implies that demand for office space will remain robust on the back of growing business activities and employment opportunities. 
  • In addition, with the cap rates for National CBD office assets now down towards 10-year lows on the back of strong capital inflows, investment demand has spilled over to suburban office assets. As average yield spreads for suburban office assets remain relatively high, there is still room for cap rates for suburban properties to compress further. 
  • As KORE has a large exposure to the suburban office market, it should benefit from the potential uplift in values over time.

A quality portfolio backed by an operator with extensive reach and scale. 

  • Demand drivers for each city are varied and growing, which allows KORE to tap on an extensive addressable pool of prospective tenants looking to expand or take up new space. We note that a majority of the markets that KORE has exposure to are experiencing a property upcycle with rents expected to be either accelerating or recovering. 
  • In addition, the ability to tap the expertise and extensive scale of its Sponsor’s real estate operating platform in the US (KBS) enables the REIT to be close on the ground, be at the forefront of any major leasing transactions out in the market, as well as to remain competitive and fulfil its own tenant needs.

Markets with positive dynamics 

  • We believe that the initial portfolio’s strong asset quality, location and being part of the management of the enlarged umbrella of KBS Realty in the US ensures that the properties remain competitive and stand tall among competition in their respective micro-markets.

Growth Drivers

KORE has a double-pronged growth strategy, derived from both organic and inorganic means. 

  • We see multiple growth opportunities for KORE over the coming years. Organic growth prospects are mainly generated from an under-rented portfolio with potential leasing-up of vacant space. In addition, given its gearing of c.36%, the REIT also has headroom to acquire when the opportunity arises. 
  • Over FY18F-19F, we project a 4.2% growth in gross revenues and a 3.5% increase in net property income.

Periodic rental uplifts in a majority of leases ensure a steady growth profile. 

  • The properties are well positioned to experience strong organic growth delivered through built-in rental escalations embedded into their lease contracts. As of 30 June 2017, approximately 97.5% of leases for the initial portfolio have built-in annual rental escalations, a majority of which are between 2.0% and 3.0%, thus providing a visible and growing rental income stream.

A long WALE of 3.7 years offers strong income visibility. 

  • With leases typically signed for 3-5 years and an average of c.16- 17% of the REIT’s cash income expiring per year, we see opportunities for KORE to ride the positive momentum across its key office markets of Austin, Seattle, Atlanta and Orlando.

Upside from optimising portfolio returns 

Rental uplifts in a majority of leases ensure a steady growth profile. 

  • Keppel-KBS US REIT (KORE)'s portfolio of properties are well positioned in their respective markets to deliver strong organic growth as the leases roll over in years. In addition, part of the growth is expected to be driven by projected higher occupancy rates going into FY18-19F to c.90.8% by the end of FY19F.
  • One of the key drivers of occupancy rate increases is expected to come mainly from The Plaza Buildings and Bellevue Technology Center in Seattle where the properties’ occupancy rates are currently below market levels. We believe that this is likely to be transitional in nature as the manager looks to the market and re-let the space to other tenants. Given that market occupancy levels at the respective sub-markets are higher at close to c.95-97%, we believe that KORE can re-let the space out to prospects.
  • In addition, we are projecting strong rental reversions to the tune of up to 26% over FY18F-19F across the portfolio and we see higher potential from its properties in Seattle (The Plaza Buildings and Bellevue Technology Center), Austin (Great Hills Plaza and Westech 360) and Atlanta (Powers Ferry and Northridge Center).

Inorganic growth via acquisitions 

A real estate market with strong depth, transparency and liquidity. 

  • The US real estate market is one of leading investment destinations for both private and public markets, in our view. Given its depth, liquidity and transparent investment framework, the real estate market in the US remains one of the key investment destinations for investors globally.
  • According to Cushman & Wakefield, we understand that real estate investors have typically focused on major markets, such as Boston, New York, Los Angeles, Chicago, Washington, D.C. and San Francisco but given that yield spreads in these markets have been compressing, interest has shifted to the other secondary tier markets which offer wider-than-average yield spreads.

Reputable Sponsors and US Asset Manager with Strong Track Records 

Reputable Sponsors. 

  • Keppel-KBS US REIT (KORE)’s manager is jointly owned by Keppel Capital (KC) and KBS Pacific Advisors Pte Ltd (KPA) who are also the Sponsors of the REIT. 
  • Keppel Capital (KC) is the asset management arm of Keppel Corporation Limited which is listed on the Singapore Stock Exchange (SGX). 
  • Meanwhile, KBS Pacific Advisors Pte Ltd (KPA) is linked to KBS which is one of the premier commercial real estate investment managers in the US. KPA is owned by Peter McMillan III, Keith D. Hall, Rahul Rana and Richard Bren. Peter McMillan III and Keith D. Hall are founding partners of KBS, and collectively own a one-third indirect interest in KBS.
  • KBS performs the role of the manager of KBS SOR, from whom KORE is buying its initial portfolio from. In addition, KBS has been appointed as the US Asset Manager.

Expertise in office real estate and fund management. 

  • Both Keppel Capital and KBS have a proven track in office real estate and fund management.

Keppel Capital (KC) – 
  • Keppel Capital (KC) is the asset management arm of Keppel Corporation Limited and is a premier manager of real estate assets in Asia. It manages a diversified portfolio of real estate, infrastructure and data centre assets in over 20 cities globally. Its strong track record can be seen by the strong growth in AUM for its REITs, trusts and funds. Its AUM, which stood at c.S$2bn in 2006, had grown to S$26bn as at 30 June 2017. Keppel Capital’s AUM comprises Real Estate (73.2%), Infrastructure (15.8%) and Data Centres (11.0%). 
  • Keppel Capital has an experienced team with over 200 professionals. Its asset managers include Keppel REIT Management Limited, the manager of one of Asia’s largest commercial REITs - Keppel REIT; Keppel DC REIT Management Pte. Ltd. (the manager of Asia’s first pure-play data centre REIT - Keppel DC REIT), Keppel Infrastructure Fund Management Pte Ltd (the Trustee-Manager of one of the largest Singapore infrastructure-focused business trusts - Keppel Infra Trust), and Alpha Investment Partners Limited (Alpha, the manager of several private equity funds).
  • Keppel Capital has, over the years, also established a strong track record in the office sector especially with Keppel REIT Management Limited and Alpha. Keppel REIT is one of the largest REITs listed on the SGX with AUM of over S$8bn. It owns premium office towers strategically located in the central business districts of Singapore, Melbourne and Sydney. Meanwhile, Alpha is a real estate investment advisory firm with gross value of its AUM amounting to over S$11bn when fully invested.
KBS – 
  • KBS is one of the premier commercial real estate investment managers in the US, with over US$33bn of transactional volume completed since its inception in 1992. It is ranked as the eleventh largest US owner of office properties globally. KBS currently manages an AUM of more than US$11.4bn in 16 funds (seven public REITs and nine private funds) across 30 markets in the US. Its portfolio comprises more than 41.8m sqft of NLA and a diversified clientele of over 3,000 tenants.
  • KBS has, over the years, developed strong expertise and track record in fund management, having launched over 30 different institutional investment funds including multiple commingled funds, separate accounts and seven publicly registered non-traded REITs. Through its vertically integrated platform in commercial real estate and in-depth knowledge of the US real estate market, KBS is an established asset manager with the capability to optimise portfolio performance for yield maximisation. Funds under management cover opportunistic, value-add, core plus and core strategies. 
  • Headquartered in California and with a team of more than 180 experienced and dedicated specialists across the US, KBS is focused on acquiring best-in-class assets that meet the demands of today’s tenants and generate sustainable returns for investors.

Sponsor Allocation Process

  • To managed any potential conflicts of interest in managing various property funds, both Keppel Capital (KC) and KBS have an allocation process to treat all clients fairly. 
  • Do note that there are currently no funds managed by Keppel Capital which has a competing or similar mandate with KORE. All deals sourced directly in an exclusive, non-auction context by KORE are not subject to this process. 


Country risks. 

  • Keppel-KBS US REIT (KORE) is exposed to country risks including economic changes, political changes or policy changes in the US where its properties are located. As the US economy is affected by global economic conditions, a change in the strength of the global economy might result in a downturn in the economy in the US which might negatively affect tenant demand for space at KORE’s properties. This in turn could negatively impact rental income and distributions to unitholders.
  • In addition, KORE will be impacted by changes in the real estate market conditions in US. Any changes in supply or reduced demand for real estate assets will have an impact on tenant demand and the attractiveness of its properties to investors.

Interest rates risks. 

  • Interest rates are expected to increase after the US Fed’s withdrawal of stimulus. As such, KORE might face higher borrowing costs and increased interest rate risk going forward, and these will have a negative impact on distributions. However, we note that the Manager intends to hedge at least 75% of its borrowing costs.

Risk of non-renewal and non-replacement of leases. 

  • KORE’s financial condition and results of operations and capital growth may be adversely affected by the bankruptcy, insolvency or downturn in the businesses of one or more of the tenants as well as the decision by one or more of these tenants not to renew their lease at the end of a lease cycle, or terminate their lease before it expires.

Relatively low retention rate. 

  • We understand, the Manager has assumed a retention rate of between 60-75% which is low compared to the experience for Singapore office REITs.
  • This may result in higher leasing commissions and/or frictional occupancy as it may take time to find replacement tenants.
  • Nevertheless, given the markets where the REIT’s properties are located are in an upturn, this relatively low retention rate may allow the REIT to better capture the increase in market rents. In addition, this retention is consistent with the markets that the initial portfolio is located in.

Large exposure to the suburban office segment.

  • Approximately 80% of the KORE’s portfolio is located in suburban locations of which 31% are Class B/B+ suburban buildings. During a downturn, there may be a flight to quality as tenants move to buildings that are better specified or in more prime locations/CBD for the same rents. This could result in a large fall in rents and/or property values. However, we understand that many tenants in the REIT’s properties generally prefer to be located in the suburbs rather in CBD locations and the REIT’s properties are well located which partially mitigates the “flight to quality” during a downturn. 

Increase in gearing assuming debt-funded capex and leasing costs. 

  • Assuming 100% of the REIT’s capex and leasing costs are debt funded, the REIT’s gearing is projected to steadily increase over time. While gearing is expected to remain below the 45% statutory limit over the next few years, assuming no revaluation gains or equity raisings, the regulatory cap may be hit in the medium term.

Foreign currency risks for investors electing to receive distributions in SGD. 

  • All of the trusts’ assets are located in the US and generate revenues in USD. Thus, investors who elect to receive distributions in SGD are exposed to volatility in the USD/SGD FX rate. This is mitigated should investors elect to receive distributions in USD. 
  • KORE does not intend to hedge its USD distributable income.

Regulatory risks. 

  • KORE's tax efficiency relies in part on its Parent US REIT and Sub-US REITs being able maintain their status as US REITs as well as the trust qualifying for US Portfolio Interest exemption when repatriating cashflows back to Singapore as interest.
  • Should there be any changes in tax or REIT regulations in either the US or Singapore which affect the current trust structure or ability to repatriate cash in a tax efficient manner, distributions paid to KORE unitholders may be adversely impacted.

Ownership limits. 

  • Unitholders are subject to the Unit Ownership Limit, that is, they are prohibited from directly or indirectly owning in excess of 9.8% of the outstanding units.
  • This is to ensure the trust’s favourable tax status. Should a unitholder exceed the 9.8% threshold, the trustee has the right and power to dispose of any units in excess of the ownership limit.


  • Keppel-KBS US REIT (KORE)’s fees in line with S-REIT industry average. We believe that Keppel-KBS REIT’s fee structure is highly aligned to unitholders’ interests and is in line with that in the S-REIT space. The REIT Manager will take 10.0% of distributable income as base management fees and 25% of the growth in DPU vs the previous financial year, as performance fees.
  • Other fees include trustee fees, acquisition and divestment fees, as well as property management fees. Based on our estimates, KORE’s fees payable as a percentage of total property value is approximately 0.50%, which is in line with the S-REIT industry average of 0.54%.
  • Majority of fees in units. The Manager has elected to receive 100% of the base management fee and performance fee in units for FY18F and 75% of its fees in units for FY19F.

FINANCIALS – Income Statement 

Steady 6.7% per annum growth in Gross Revenues. 

  • We project Keppel-KBS US REIT (KORE)’s top line to grow at 6.7% per annum over FY17 (annualised) to FY19F underpinned by
    1. in-built annual rental escalations of 2-3% per annum for 97.5% of its Initial Portfolio’s leases,
    2. improvement in portfolio occupancy which is projected to rise from 88.1% in 1H17 to 90.8% by end-FY19, and
    3. positive rental reversions given average expiring rents in FY18 and FY19 are 23.5% and 26.0% below current average market rents.

16% jump in NPI over the next two years. 

  • On the back of the healthy growth in rental income, we project KORE’s NPI to jump 16% from US$48.5m for annualised FY17 to US$56.3m in FY19F. This is equivalent to compound annual growth of 7.7%. Over this period, NPI margins are expected to show some modest improvement, 57.3% for annualised FY17F, 58.8% in FY18 and 58.4% in FY19.

Management fees – pegged to distributable income. 

  • The base fees and performance fees of KORE are structured to motivate the Manager to grow revenues and keep costs in check, ensuring that interests of the Manager are well aligned with that of unitholders. Annual base fees are paid based on 10% of distributable income. In addition, the Manager will only be paid an annual performance fees that is based on 25% of the growth in DPU in a financial year compared to the preceding year. 
  • For FY18F and FY19F, no performance fee will be payable. The Manager has elected to received 100% of the management fees (base fee and any performance fee) in units and at least 75% of the management fees in units.

All-in-interest cost of 3.35%. 

  • Interest expenses are expected to remain relatively stable as the trust has obtained two debt facilities with a weighted average debt maturity of 4.5 years and intends to hedge at least 75% of its interest rates. The average effective interest cost (inclusive of upfront fees) is expected to be 3.35%.

Non tax-deductible expenses. 

  • Largely consists of management fees payable to the Manager, non-cash property tax adjustments and the amortisation of upfront fees.

Distribution income – 100% till FY2019F. 

  • KORE’s distribution policy is to distribute 100% of its annual distributed income to the end of FY19F. Thereafter, the trust will have a distribution payout of at least 90% of its distributable income.
  • Distributions will be made on a half-yearly basis. The first distribution will be paid on or before 30 September 2018 for the period till end-30 June 2018. Thus, based on the growth in NPI, we project distribution income to increase by 7% from FY18F to FY19F.

6% DPU growth. 

  • On the back of the growth in NPI, partially offset by higher interest costs on the back of an increase in borrowings and issuance of management fee units, we project KORE’s DPU to increase by 6% between FY18 and FY19F.

FINANCIALS – Balance Sheet 

Purchase consideration of US$804.0m. 

  • The total purchase consideration of the initial portfolio is US$804.0m which is at a discount to the appraised value of US$829.4m. The appraised value is the higher of two valuations by JLL and Colliers. 
  • In terms of contribution by value, the five largest properties are Plaza Buildings (29.4%), Bellevue Technology Center (16.0%), Westmoor Center (14.6%), 1800 West Loop (9.9%) and West Loop I & II (6.1%).

Total loans of US$287m. 

  • Initially Keppel-KBS US REIT (KORE)’s will have initially borrowings of US$287m, consisting of two facilities that mature in 2021 and 2022. The weighted average debt maturity is 4.5 years. The REIT will also have a US$50m threeyear committed revolving facility to help fund its future capex and leasing costs.

Interest costs of 3.35%. 

  • The expected weighted average interest cost is expected to be 3.35% and KORE intends to hedge at least 75% of its interest rate exposure.

Initial aggregate leverage of approximately 36%. 

  • Based on our estimates, KORE will have an initial aggregate leverage of around 36%. However, with capex and leasing costs expected to be debt funded, we expect gearing to rise to c.38% by end-FY19. We understand KORE intends to keep its gearing at 35-40%.

FINANCIALS – Cashflow Statement 

Acquisition of initial portfolio. 

  • We have assumed the total acquisition costs (inclusive of fees) for the initial portfolio at US$804m. Acquired in FY16P, the acquisition will be funded through
    1. new debt issuance and
    2. unitholders’ funds of US$554m.

Other Non-Cash Adjustments. 

  • Largely consists of management fees payable to the Manager, non-cash property tax adjustments and the amortisation of upfront fees for loan disbursement.
  • Capex requirements. We have assumed US$17.3-24.9m of capex and leasing costs over FY17F-18F. We have assumed that that the capex and leasing costs will be funded with debt.


Discounted Cash Flow Method 

  • Keppel-KBS US REIT (KORE) generates stable income from its long leases, with portfolio WALE averaging 3.7 years (by NLA) and in-built annual rental escalations of 2-3% per annum. As such, discounting its cashflows would provide an appropriate valuation method. 
  • Our DCF analysis has factored in a normalised US risk-free rate of 2.75%, US market return of 9.1%, beta of 0.95x (a premium to the average US office REITs beta of 0.9x due to KORE’s smaller size, larger exposure to the suburban office market and expectations that gearing climbs towards the 40% level in the medium term), cost of debt of 3.4% and cost of equity of 8.8%. 
  • We have used a target gearing of 40%, given projections that gearing will rise towards the 40% level from an initial 36% level as capex and leasing costs are expected to be debt funded. This translates to a WACC of 6.6%. Coupled with a terminal growth rate of 2.5%, we derive a DCF valuation of US$0.95. This implies a FY18F and FY19F yields of 6.3% and 6.7% respectively.

Premium to book justified 

  • Similar to Manulife US REIT (MUST), the first REIT listed in Singapore with US office assets, we believe KORE should trade at a premium to book given that KORE’s properties are located in office markets that are generally on an upswing. Our Target Price of US$0.95 implies a P/Bk of c.1.15x.
  • Looking at historical performance for office REITs in Singapore and using CapitaLand Commercial Trust (CCT) and Keppel REIT (K-REIT) as proxies, we found that the sector trades in a wide valuation range of 0.7-1.6x across market cycles (ignoring the financial crisis back in 2009). Over the past office market up-cycles of 2005-2008 and 2013-2015, we note that office REITs (CCT & K-REIT), trade up to a high of 1.6x P/Bk NAV and 1.0x P/Bk NAV respectively. 
  • We have not used the P/Bk experience of US office REITs as the US-based P/Bk is not a comparable metric. The US REITs do not mark to market the value of their properties but rather depreciate their properties which are recorded at cost.
  • With KORE’s properties expected to experience positive rental reversions and are leveraged to the upturn in spot rents with additional upside from acquisitions, we believe investors will anticipate a potential rise in property values. Therefore, we believe it is justifiable for KORE to trade up to 1.15x P/Bk. 
  • Do note that we have pegged KORE at a discount to Manulife US REIT where our Target Price implies a P/Bk of 1.20-1.25x given Manulife US REIT has demonstrated a track record of outperforming and buying assets assertively. In addition, we believe a Manulife US REIT’s premium is also justified given its larger exposure to Grade A properties.

Yield to compress from current levels as implied by our TP 

  • We believe the most valid yield comparisons for Keppel-KBS US REIT (KORE) are
    1. Manulife US REIT (MUST) which is currently the only REIT listed in Singapore with US office assets, and
    2. office REITs listed in the US.
  • Manulife US REIT currently trades on a FY18F and FY19F dividend and FFO yield of 6.6% and 6.9% respectively. Since there are no withholding taxes payable for Singapore residents or non-residents, Manulife US REIT’s post tax FY18F and FY19F post tax remains at 6.6% and 6.9% respectively.
  • Meanwhile, US-listed office REITs trade at an average FY18F and FY19F dividend of 3.1% and 3.2% respectively. However, we note that this is typically after cash is retained for capital adjustments (usually capital expenditure and tenant improvements). This means that most US-REITs do not pay out 100% of their cashflows, which is unlike S-REITs, which typically pay out 90-100% of distributable income. The average pay-out ratio for the US office REITs calculated as a percentage of FFO stands at around 52%. 
  • On an adjusted basis (assuming 100% payout ratio), the FY18-19F pre-tax dividend yield/FFO yield averages 6.0-6.3%. Post tax (30% withholding tax is applied to dividends for foreign investors), the yield drops to 4.1-4.4%. Thus, given KORE’s near-term robust DPU outlook and tax efficiency relative to its US peers, we believe, KORE’s FY18F DPU has the potential to compress from the current 6.6% level to 6.2% as implied by our Target Price of US$0.95. However, this would be at a 20-bp premium to the average FY18F FFO yield for US-listed office REITs. 
  • The premium in our view is justified given its smaller size, limited track record and larger exposure to Class B/B+ buildings despite its more efficient tax structure which minimises the withholding tax payable when repatriating cash from the US.
  • In addition, we believe KORE’s target yield should also trade at a slight premium to Manulife US REIT’s target yield of 6.1% despite KORE’s faster DPU growth profile, as KORE has exposure to Class B/B+ properties which Manulife US REIT does not have. 
  • Manulife US REIT has a proven track record of outperforming its prospectus forecasts and has shown the ability to identify DPU accretive acquisitions. However, we do note, should KORE consistently demonstrate superior DPU growth, there is potential for the REIT to trade closer to our Manulife US REIT Target Price’s target yield of 6.1%.

Mervin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2018-01-15
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