Manulife US REIT - RHB Invest 2018-12-14: Fundamentals Remain Sound


Manulife US REIT - Fundamentals Remain Sound

  • Maintain BUY, Target Price of SGD0.92, 21% upside with 8.2% FY19F yield.
  • Manulife US REIT remains a good proxy to the sound US office fundamentals, through its portfolio of seven high-quality commercial assets across the US. The outlook for US office space remains rosy on strong job creation and limited micro market supply.
  • While there have been some concerns based on potential tax reforms impacting its tax-efficient structure, we believe the probability of any drastic changes is low.

Positive rental reversions to continue.

  • The outlook for office demand in key gateway cities remains positive, with the continued improvement in the labour market and unemployment at record-low levels of 3.9%. This is reflected in continued positive rental reversions (+10.2% in 9M18) for Manulife US REIT, on top of its stable portfolio occupancy rate (96%) and higher valuations for its properties.
  • The supply of office space (2018-2020) across the micro-markets where its assets are located also remains minimal. As such, we expect rental reversions to stay positive at 3-7%, for 2019.

Debt cost to increase slightly, mitigated by organic rental rate growth.

  • While Manulife US REIT’s portfolio debt is currently fully hedged, about USD108.5m (16% of total) of its loans are due for renewal in Apr 2019. As borrowing costs have risen considerably from the time of financing, we expect overall borrowing costs to increase by 30-40bp upon refinancing. However the impact will be cushioned by the organic rent growth from inbuilt rent escalations.
  • About 94% of Manulife US REIT’s rental portfolio have built-in annual rent escalation clauses and mid-term/periodic rental rate increases. On average, this should result in 2.1% pa growth in overall portfolio rental rates.

Speculation surrounding tax changes seems overdone.

  • There has been market speculation on potential tax reforms by the Trump administration, which could impact the current tax-efficient structure employed by Manulife US REIT. The speculation surrounds changes to the US portfolio interest exemption rule – which shields withholding tax on interest and principal on shareholder’s loans.
  • While visibility on this issue is still low, the probability of any drastic change is also small. This is as the current structure is used by a large number of private funds, and the change will have a broader impact on foreign investments in the US.
  • Management has also been proactively evaluating counter-measures in the form of increasing depreciation charges or changing the tax domicile entity, which could limit the impact such changes, if they take place. The worst-case impact is likely to be a 15% drop in distributable income.

Valuations are compelling.

  • Manulife US REIT offers a FY19F yield of 8.2%, which we find highly attractive. Our DDM-based Target Price is based on a CoE of 8.5% and terminal growth of 2%.
  • Key risks are changes to its tax-efficient structure, the ability to retain key tenants and an unexpected slowdown in office space demand.

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2018-12-14
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