Manulife US REIT - RHB Invest 2018-04-16: Adding More Crown Jewels

Manulife US REIT - RHB Invest 2018-04-16: Adding More Crown Jewels MANULIFE US REIT BTOU.SI

Manulife US REIT - Adding More Crown Jewels

  • Manulife US REIT’s latest acquisition of two quality assets from its sponsor demonstrates its inorganic growth ability and reiterates strong sponsor commitment towards its growth. Both the assets have excellent attributes which include good location, strong tenants and a long WALE, complementing its existing assets. 
  • While we note that there is some concern on the REITs rapid pace of acquisition-led growth, we believe that acquisitions have not compromised unit holders’ interests and would ultimately benefit them. 
  • Maintain BUY with a Target Price of USD 1.00 (9% upside).

Acquisition checks all the right boxes. 

  • Manulife US REIT (MUST) on Friday announced the acquisition of 1750 Pennsylvania Avenue (Penn), in Washington DC and Phipps Tower (Phipps), in Atlanta for an aggregate purchase cost of USD387.0m (c.2% discount to the average of two independent valuations). 
  • The acquisition’s net property income (NPI) yields for Penn and Phipps are 5.2%/5.9% respectively, in-line with latest market transactions. 
  • The transaction is yield accretive (1.4% accretion to Pro Forma FY17 DPU) assuming a combination of funding via debt and perps. Both assets possess excellent location attributes, quality tenant base which complements well Manulife US REIT’s existing portfolio. In addition, the assets are also recently completed and renovated minimising immediate capex requirements.

Strong tenant base and long weighted average lease expiry (WALE) provide stability. 

  • For Penn, which is located blocks away from the White House, c.85% of the building is occupied by the US Government and global agencies, with the Department of Treasury and the United Nations Foundation being the anchor tenants. The building has a long WALE of 6.8 years with minimal expiries until 2020. 
  • In Phipps, Carter’s (listed major American designer and marketer of children’s apparel) is the major tenant occupying c.65% of the building. 
  • The asset has a WALE of 10 years with minimal expiries until 2023. In addition, both asset have rent escalations of 2% to 3% pa, except for the government agencies.

Passing rents 12-25% below market average rents. 

  • Penn’s passing gross rent of USD 48.90psf, is c.12% lower than market rents of USD 55psf, while Phipps passing net rents of USD22.20psf are c.25% lower than market rents of USD30 psf. 
  • While the near-term upside is minimal due to locked-in leases, the under-rented portfolio presents good room for organic rent growth in the future.

Funding structure. 

  • The acquisition is expected be funded by a combination of debt and equity/perpetual securities (perps). Manulife US REIT has set up a USD1bn Multicurrency Debt Issuance Programme which can be used to issue perps. However, the final mix of funding will be decided at a later date based on market conditions. 
  • For debt, management has assumed a 4-year fixed-term loan at 4.5% pa, which we believe is fairly conservative. We have currently assumed a 50-50 perps/debt structure in our model.

Maintain BUY, revised Target Price of USD1.00 (USD0.98 previously). 

  • Our FY18-20F DPU forecasts increases by 1% - 2%, after factoring in acquisition contributions.
  • Our DDM derived Target Price is based on a cost of equity of 8.0% and a TG of 2%.

Property Details & Market Overview 

Penn is a 13-storey Class A office building totalling 277,243 sqft (occupancy: 97.2%). 

  • The building was constructed in 1964 and major renovations were implemented between 2012 and 2018, including the addition of a state-of-the-art fitness centre, a restroom and common corridor refurbishment, mechanical work and a garage modernisation.
  • Location. Penn is within three blocks to Farragut North and Farragut West Metrorail Stations and is strategically located between the White House one block to the East and the World Bank headquarters one block to the West, and is a short distance to the headquarters of the International Monetary Fund, the Federal Reserve and George Washington University. There is also easy access to Lafayette Square, Blair House and many US governmental agencies.
  • Washington CBD market overview. According to JLL, the CBD submarket is historically Washington, DC’s strongest fundamentally, carrying a 10-year average vacancy rate of 10.7%, the lowest in the city. A large development pipeline, combined with continued givebacks and consolidation from key users is exacerbating a flight to quality and divergence in vacancy trends . Due to its diversity and geographic advantages, the CBD has been more resilient than other submarkets and as a result, annual rent and vacancy trends have been relatively stable.
  • Currently in the CBD submarket, similar value-oriented Class A buildings as Penn are being demolished, renovated or repositioned, hence creating an opportunity for Penn in terms of capturing further leasing activity from technology, media, non-profits, associations and creative sector tenants. Vacancy within the White House West micro market, where Penn is located, is at 3.6%, well below the overall vacancy rate in the CBD submarket.

Phipps is a 19-storey Trophy quality office tower totalling 475,091 sqft (occupancy: 97.3%) in the heart of Buckhead, Atlanta. 

  • It is part of the 8-building Trophy set of the Upper Buckhead micro market in Atlanta. 
  • Phipps offers various facilities to its tenants, such as a farm-to-table café, a sundry shop, a fitness centre and a conference centre. There are five levels of covered parking with 1,150 parking stalls, as well as designated electric vehicle charging stations. The property is also LEED-CS Gold certified. 
  • Phipps is the global headquarters of Carter’s, the major American designer and marketer of children’s apparel, on a 15 year lease expiring in 2030.
  • Connectivity and amenities. Phipps is in close proximity to interstate highways I-85, I-285, and I-75. In addition, Phipps is also within walking distance of the Buckhead MARTA station. Phipps also provides good accessibility and convenient area amenities including direct covered access to the super-regional Phipps Plaza shopping centre, one of the most exclusive shopping environments in the neighbourhood.
  • Buckhead submarket overview. According to JLL, Buckhead remains Atlanta’s premier submarket, traditionally commanding the highest rents and one of the lowest vacancy rates in the entire metro area. The Buckhead Class A office market has enjoyed positive absorption for eight straight years, resulting in compressed vacancy and increasing direct asking rents. Office rents in Buckhead have generally commanded a premium of over 30%, above the overall Atlanta office rents in recent times. This solid rent growth is expected to continue into the future as Buckhead remains the most coveted office location in metro Atlanta.
  • After a few strong quarters of deliveries, Buckhead currently has no major sites under construction. This limited supply coming online due to a scarcity of building sites, and increased construction costs, will result in landlord-favourable conditions continuing.
  • Buckhead is expected to remain a driver of growth in the Atlanta office market, responsible for a disproportionate share of future leasing, construction and sales activity.

Vijay Natarajan RHB Invest | 2018-04-16
RHB Invest SGX Stock Analyst Report BUY Maintain BUY 1.00 Up 0.980