Manulife US Real Estate Inv - DBS Research 2018-02-07: Up Up And Away

Manulife US Real Estate Inv - DBS Vickers 2018-02-07: Up Up And Away MANULIFE US REIT BTOU.SI

Manulife US Real Estate Inv - Up Up And Away

  • Manulife US Real Estate Inv (Manulife US REIT)'s 4Q17 DPU of 1.42 Scts (+7.6% y-o-y) above expectations largely due to better margins.
  • Portfolio well positioned to capture the expected increase in market rents.
  • Strong growth in DPU in FY18F on the back of full year contribution from recently acquired 500 Plaza Drive and 10 Exchange Place.

REIT that delivers. 

  • We maintain our BUY call on Manulife US Real Estate Inv (Manulife US REIT) with a revised Target Price of US$1.00. 
  • Hallmarks of a successful REIT include a management team delivering on their promises and owning properties with strong fundamentals. Since its listing 1.5 years ago, Manulife US REIT has delivered with DPU exceeding IPO forecasts, property values increasing by over 10%, and the ability to identify DPU-accretive acquisitions. 
  • With the recent US tax cuts expected to spur economic activity and demand for office space, we believe Manulife US REIT remains an attractive investment as its original investment thesis of rising rents and improving capital values remain intact.

Where we differ – Premium to book. 

  • While consensus is bullish on its US exposure, pegging target prices at P/Bk of c.1.10x, we believe Manulife US REIT deserves to trade at a higher P/Bk of c.1.20-1.25 given its ability to execute on DPU-accretive acquisitions and upside risk to its portfolio values as the US office market remains on an up-cycle. 
  • Moreover, an additional growth premium is justified, given that near-term DPU growth is 2-3 times higher that of other listed S-REITs.

Acquisitions to be the next growth driver. 

  • With gearing to stabilise at around the 33-34% level post its recent acquisitions, given the debt headroom available, we believe additional acquisitions will remain a key share price re-rating catalyst going forward. 
  • We understand markets that are of interest are core submarkets that enjoy demand from diversified industries (i.e. manufacturing, financial, technology and law firms) which imply stability across market cycles.


  • After projecting stronger earnings but partially offset by higher assumed risk-free rate of 3% versus 2.5% previously, we raised our DCF-based Target Price to US$1.00 from US$0.99.

Key Risks to Our View

  • The key risk to our view is lower-than-expected rental income, arising from non-replacement/renewal of leases and/or slowerthan-expected recovery of office rents in the US

WHAT’S NEW - Strong end to the year

4Q17 DPU up 7.6% y-o-y

  • Manulife US REIT (MUST) delivered 4Q17 DPU of 1.42 UScts (+7.6% y-o-y) taking FY17 DPU to 5.53 UScts which was above our 5.34 UScts estimate. 
  • The better than expected results were due to improved NPI margins (63% versus our 62% estimate) and lower than expected borrowings costs.
  • Underlying 4Q17 revenue and NPI rose 51.5% and 48.9% y-o-y respectively, largely due to the recent acquisition of the Plaza and Exchange properties.

Continued increase in passing rents

  • On the back of 12.2% positive rental reversion achieved in 2017, passing rents at all of Manulife US REIT’s properties continued their steady uptrend.
  • Average gross rents at Figueroa now stand at US$39.49 psf pa up from US$39.39 at end 3Q17 and 7.4% higher than US$36.78 at end 4Q16.
  • Likewise rents at Michelson came in at US$49.27, up 0.8% q-o-q (3Q17 rents were affected by the renewal of a key tenant) but flat y-o-y.
  • Peachtree gross rents also increased to US$31.83 from US$31.70 at end 3Q17 and US$31.01 at end 4Q16.
  • For the Plaza and Exchange, passing rents have risen to US$30.09 and US$39.73 from US$29.19 and US$38.18 respectively at the time of acquisition.
  • Heading into 2018, we expect Manulife US REIT to continue to report a steady increase in passing rents given the upturn in market rents and inbuilt rental escalations. In terms of lease renewals around 2.6% of leases by cash rental income are set to be renegotiated in FY18, followed by 12.2% of leases in FY19.

Marginal q-o-q uptick in occupancies

  • Overall portfolio occupancy rose marginally to 95.9% from 95.7% at end 3Q17. This was largely contributed by an increase in Figueroa (92.9% versus 92.1% at end 3Q17). Nevertheless, on a y-o-y comparison, portfolio occupancy fell from 97.0% owing to a loss of some tenants at Figueroa (97.5% at end 4Q16). 
  • For Manulife US REIT’s other properties, occupancies were stable with the exception of the Exchange which saw occupancy drop to 95.7% from 97%. Occupancies for Michelson, Peachtree and Plaza were maintained at 96.5%, 96.8% and 98.9% respectively.

Increase in property values but increase in gearing

  • Gearing inched up to 33.7% from 33.1% at end 3Q17 despite recording 2% increase in property valuations from its last assessment in June 2017. The increase in property values was largely a function of increases in income, with cap rates for Manulife US REIT’s three initial properties increasing by 10 bps. For Manulife US REIT’s two newest properties, the valuation of Plaza and Exchange rose 2.6% and 5.6% respectively. 
  • Overall portfolio cap rates now stand at 5.5%, up from 5.3% at end 2Q17 partially due to the higher cap rates for Plaza which stand at 6.4%.
  • Average borrowing costs also rose to 2.83%, up from 2.46% at end 3Q17 as borrowings costs for Manulife US REIT’s acquisitions were higher than its interest costs at IPO. Going forward, Manulife US REIT will seek to un-encumber its assets, which should result in slightly higher borrowings costs. However, we understand to manage interest costs, it may reduce the proportion of fixed rate debt from 100% level currently. 
  • Furthermore, to manage its level of borrowings, Manulife US REIT intends to introduce a distribution reinvestment plan (DRP) for FY18 DPU and beyond.
  • NAV per unit now stands at US$0.82, down from US$0.87 at end December 2016, owing to the higher units on issue post the equity placement and rights issue.

US tax changes a net positive

  • Following the recent changes in the US tax regime, we understand Manulife US REIT was unable to claim certain tax deductions. To resolve this issue, entities were setup in Barbados which have a tax rate of between 0.25- 2.50% with interest on shareholders’ loans streamed from the US to Singapore via Barbados. The net impact from this new structure is less than 1% to Manulife US REIT’s DPU.
  • On a positive note, the new tax codes no longer have thin cap rules, which will allow Manulife US REIT to hold more shareholders’ loans in its US entities, thereby reducing overall tax leakage in the long term. 
  • Furthermore, we believe the reduction in corporate tax rates should spur increased economic activity translating to higher office demand.

Medium term ambitions to strengthen the portfolio

  • Manulife US REIT announced that it intends to double the size of its assets under management to US$2.6bn over the next couple of years.
  • While we believe some investors may react negatively to this guidance given concerns of Manulife US REIT pursuing acquisitions just for growth sake, we are supportive of its growth strategy primarily due to Manulife US REIT showing financial discipline thus far and being able to identify DPU-accretive acquisitions.
  • Furthermore, in our view, an enlarged portfolio should bring further diversification benefits and the resultant larger market cap (Manulife US REIT will need to raise equity to fund the growth in assets) should translate to a tighter yield over time.
  • Finally, with the US already on a multi-year upturn, it is best for Manulife US REIT to seize opportunities now rather than wait.

Refurbishments to boost competitive position

  • Over the coming year, Manulife US REIT plans to undertake asset enhancement initiatives (AEI) at its Figueroa and Exchange properties.
  • Starting in 2Q18, the main lobby at Figueroa will be renovated at a cost of US$5m. The old waterfall in the lobby will be replaced with a new café generating additional income for the REIT.
  • At the Exchange, not only will be the lobby be refurbished, the common space will be spruced up and additional equipment such as new turnstiles will be acquired. Starting 3Q18, the total costs of the project will be c.US12m.

Raising DPU estimates and TP

  • On the back of the better than expected 4Q17 results but partially offset by higher shares on issue due to the introduction of the DRP (we assumed 15% take up rate), we increased our FY18-19F DPU by 5%.
  • We have also raised our DCF-based Target Price to S$1.00 from S$0.99 previously. The small increase in our Target Price as compared to our DPU estimates is largely due to higher assumed risk-free rate (3.0% versus 2.5% previously) and long term borrowing costs. Our Target Price of S$1.00 still implies a P/Bk multiple of 1.20-1.25x which we believe is justified given the US office market is on an upturn and superior near term DPU growth.

Maintain BUY with revised TP of S$1.00

  • With rents across its portfolio still on an uptrend and passing rents on average still 5-10% below market, we believe Manulife US REIT remains an attractive investment opportunity.
  • Thus, combined with a strong 14% DPU growth in FY18 on the back of the full year contribution from acquisitions made over the past year and attractive 6.9% yield, we maintain our BUY call with a revised Target Price of S$1.00.

Mervin SONG CFA DBS Vickers | Derek TAN DBS Vickers | http://www.dbsvickers.com/ 2018-02-07
DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 1.00 Up 0.990