Manulife US Real Estate Inv - DBS Research 2018-08-07: Stars Still Aligned

Manulife US Real Estate Inv - DBS Group Research Research 2018-08-07: Stars Still Aligned MANULIFE US REIT SGX:BTOU

Manulife US Real Estate Inv - Stars Still Aligned

  • Manulife US REIT’s 2Q18 DPU of 1.30 UScts (-10% y-o-y) in line with expectations. 
  • Drag from extra units from recent rights issue but only nine days' contribution from acquisition of Penn and Phipps. 
  • Stronger contribution ahead once full benefits of acquisitions flow through. 

REIT that delivers.

  • We maintain our BUY call on Manulife US Real Estate Inv (Manulife US REIT) with a Target Price of US$0.97.
  • Hallmarks of a successful real estate investment trust (REIT) include management that delivers on their promises and owning properties with strong fundamentals. Since its listing nearly two years ago, Manulife US REIT has delivered with distribution per unit (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, with its original investment thesis of rising rentals and improving capital values remaining intact.

~ ~ Where SG investors share

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 given its ability to execute on DPU-accretive acquisitions and upside risks to its portfolio values as the US office market remains on an upcycle.
  • Moreover, a premium is justified, as DPU growth over the next two years is 2-3 times higher that of other S-REITs.

Acquisitions to be growth drivers.

  • We believe additional acquisitions will remain key share price re-rating catalysts 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.


  • We maintain our DCF-based Target Price of US$0.97. With 14% capital upside and 6.5% yield, we maintain our BUY call.

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 slower- than-expected recovery of office rentals in the US.

WHAT’S NEW - Full benefits from acquisitions yet to flow through

2Q18 results in line

  • Manulife US REIT delivered 2Q18 DPU of 1.30 UScts (-10% y-o-y) which was down 10% y-o-y mainly due to the drag from additional units on issue post the recent rights issue but only nine days' contribution from the recently acquired Penn and Phipps located in Washington DC and Atlanta.
  • The results were largely in line with expectations with 1H18 DPU of 2.53 UScts representing c.50% of our FY18F DPU.
  • While the headline numbers show a decline, based on Manulife US REIT’s estimates, adjusting for the impact of the rights issue, 2Q18 and 1H18 DPU would have risen 5.5% and 2.4% y-o-y respectively.

Steady organic growth

  • On the back of the recent acquisition of Penn and Phipps as well as acquisition of Plaza and Exchange a year earlier, 2Q18 revenue and NPI jumped 63% and 59% y-o-y respectively.
  • Organically, Manulife US REIT continues to grow at a steady pace underpinned by having 2.1% p.a. annual rental escalations in 93.9% of leases and the benefits from 12.2% positive rental reversions achieved in FY17.
  • On that front, the trend of positive rental reversions continued into 2Q18, with signing rents at Figueroa and Exchange 8.0% and 7.1% higher than expiring rents respectively.

Healthy occupancies maintained

  • Overall portfolio has been maintained at a high level at 96.0% marginally up from 95.9% and 95.8% at end-2Q17 and 1Q18 respectively.
  • Within the portfolio there have been some minor movements with occupancy at Michelson dropping from 99.1% in 2Q17 and 96.5% in 1Q18 to 94.4% and Figueroa dropping to 93.0% from 95.3% at end-2Q17 (93% at end-1Q18). This was offset by occupancy at Exchange rising to 98.3% from 97% in 2Q17, with overall portfolio occupancy also being boosted by 100% and 97.4% occupancy at Penn and Phipps, which have improved from 97.2% and 97.3% at point of acquisition respectively.

Increase in valuation from change in valuer

  • As per regulatory requirements to change valuer every two years, following the appointment of Colliers instead of CBRE, on average, property values have increased by 1.4% with a range of 0-4.5%.
  • In general, Colliers compressed cap rates partially offset by lower assumed income (rents and vacancy rates). For example, cap rates for Figueroa and Micheson fell to 4.4% and 5.1% from 4.9% and 5.1% respectively while property values were up 0.6% and flat. In contrast, Plaza and Exchange saw 1.4% and 1.3% increases in valuation respectively but cap rates expanded to 6.6% and 5.3% from 6.4% and 5.2% respectively.
  • The largest increase in valuation were Peachtree and Penn which were up 4.5% and 2.7% respectively. Higher values ascribed to Peachtree were mainly due to higher income with cap rates stable at 5.9%. For Penn, the increase in valuation was mainly due to cap rates falling to 4.8% from 5.0%. Property values for the recently acquired Phipps also rose 1.1% despite cap rates being stable at 5.9%.
  • Overall, average portfolio cap rate stands at 5.3% down from 5.5% at end-December 2017, with cap rates ranging from 4.4-6.6%.

Increase in gearing

  • Despite the increase in valuations, gearing rose to 37.3% from 34.1% at end-March 2018, on the back of the recent acquisition of Penn and Phipps. However, NAV per unit rose to US$0.83 from US$81 at end-1Q18.
  • Due to higher costs of debt for the Penn and Phipps acquisition of c.4.26%, average borrowing costs also rose to 3.27% versus 2.83% previously.
  • However, 100% of Manulife US REIT borrowing costs remains fixed.
  • Going forward, Manulife US REIT is exploring various funding methods to manage its borrowing costs including potentially having some floating rate debt to as the “cheaper” debt at IPO gets refinanced over the next three years.

Positive market outlook retained

  • Based on data from CoStar, the markets that Manulife US REIT’s properties are located in continue to report increases in rents (2-7% growth) with the exception of Meadowlands, Hudson Waterfront and Washington DC which are flattish. Nevertheless, Manulife US REIT’s properties in these markets are generally under rented.
  • Furthermore, we understand there is limited new construction to be delivered over 2018-2020 for all of Manulife US REIT’s key markets except Midtown Atlanta and two markets, we understand, the pre-commitment levels for some of the upcoming buildings are high in the 50-60% range, which potentially reduces the incentive for these new buildings to cut rents. For the Washington DC market, due to the relatively high construction costs these new buildings also have to charge higher rents to hit their investment hurdle rates.

Maintain BUY, Target Price of US$0.97

  • With 2Q18 results in line with expectations, we maintain our BUY call with Target Price of US$0.97.
  • We continue to believe Manulife US REIT offers investors leverage to the upturn in the US office market at an attractively priced entry level.

Mervin SONG CFA DBS Group Research Research | Derek TAN DBS Research | 2018-08-07
SGX Stock Analyst Report BUY Maintain BUY 0.970 Same 0.970