Manulife US REIT - DBS Research 2019-06-17: Positioned To Rally Further


Manulife US REIT - Positioned To Rally Further

  • Acquisition of Centerpointe I & II in Fairfax, Virginia for US$122m and initial NPI yield of 8.3%.
  • Acquisition and lower interest rates to enhance FY19-21F DPU by 5-8%.
  • Recent visit to Atlanta and New Jersey reaffirms positive outlook for Manulife US REIT’s key markets.

Poised to move higher.

  • We maintain our BUY call on MANULIFE US REIT (SGX:BTOU) with a revised Target Price of US$1.00.
  • As anticipated, Manulife US REIT’s share price has rallied since the end of 2018 as we believed the stock was oversold due to concerns over a potential negative ruling on Manulife US REIT’s tax structure and correction of its listed peer.
  • While Manulife US REIT has moved from trading at book value at c.0.9x P/Bk to c.1.0x, we believe Manulife US REIT can potentially re-rate to c.1.2x P/Bk, as the tax concerns have largely been allayed given a favourable interim tax ruling, Manulife US REIT’s exposure to rising US office markets and a more benign interest rate environment.

Expands into Fairfax, Virginia

  • Manulife US REIT recently announced the acquisition of Centerpointe I & II, a two-tower freehold Class A office building located at Fairfax, Virginia, Washington DC Metro Area (Washington MSA) for US$122.0m and on an initial NPI yield of 8.3%. Total acquisition cost stands at c.US$127.0m, which also includes US$1.2m acquisition fee, c.US$3.8m worth of professional and other transaction fees.
  • The acquisition was partially funded via the recent US$94.0m equity raising (114.078m units at US$0.824 per unit), with the remainder funded via a five-year USD loan with a sub 4% interest rate.

Centerpointe I & II overview

  • Centerpointe I & II has a total net lettable area (NLA) of 419,981 sqft with 1,456 parking spaces. As at 31 March 2019, committed occupancy stood at 98.7%. Occupancy for the building has averaged 94.0% over the last eight years, significantly outperforming the Fairfax Center Submarket which ranged between 70-85%.
  • In addition, rental rates for the property have been at 10-25% premium to the market over the last eight years. All the leases currently have inbuilt rental escalations ranging from 2.5% to 3.0%.
  • The weighted average lease expiry (WALE) by NLA stands at 6.9 years with 0.1%, 4.5%, 13.3% and 10.2% of leases by gross rental income due for renewal in 2019, 2020, 2021 and 2022 respectively.
  • The property has 21 tenants, with the top 5 tenants by GRI being
    • ASM Research – an information and technology provider and subsidiary of Accenture
    • Edelman Financial Services – a leading US independent investment advisory practice
    • Board of Supervisors for Fairfax County – Fairfax County government responsible for establishing county policies, passing ordinances, setting tax rates and other municipal responsibilities
    • Salient Federal Solutions – a leading technology providing health, data analytics, cloud and many other solutions
    • ECS Federal – Information technology provider delivering advanced solutions to the military, federal civilian and commercial organisations and a subsidiary of NYSE listed ASGN Incorporated.
  • Approximately 50% of tenants by NLA also use Centerpointe as their headquarters.
  • The largest trade sector is information technology at 35.3% of gross rental income, followed by finance and insurance at 25.2%, public administration at 16.3%, real estate at 7.2%, legal at 6.4% and healthcare at 5.0%.

At an amenity rich location facilitating a live, work, play environment

  • The property, Centerpointe I & II, is in close proximity to ample and diverse housing, sporting facilities and education establishments which facilitates a live, work, play environment. Nearby is c.1.9m sqft of retail space, with Fair Oaks Mall, the largest mall in the submarket and second largest in the state, only a 5-minute walk away. The Fairfax Towne Center is also a 3-minute walk.
  • Located approximately 30km away from Washington DC, the property has direct access to highways with Dulles International Airport and Reagan National Airport 15 and 30 minutes’ drive away respectively.

Fairfax, Virginia / Washington MSA overview

  • Centerpointe is located in the Washington MSA which is ranked the 5th largest market in the US by GDP and 6th largest by population with a median household income of US$97,148 which is among the highest in the US.
  • With Washington DC being the US capital, the Washington MSA is an economic zone anchored by the US Federal government with many global firms within the defense aerospace, technology, financial and business services sectors having their headquarters for the region.
  • Virginia, which is part of Washington MSA and close to Washington DC, has five of the richest counties in the whole of the US. In addition, companies such as CapitalOne, Hilton Worldwide, General Dynamics and Amazon HQ2, have their headquarters in Virginia.
  • Within the Fairfax Center Submarket located in Fairfax County, 63% of residents have a Bachelor’s degree or higher, and it is an attractive location for prospective tenants. To that end, the area has an established tenant base of government contractors, financial services and technology firms. The overall median income in the area stands at US$117,515, higher than US$97,148 for the overall Washington MSA.
  • The market has c.4.8m sqft of office space, 6m sqft of retail amenities supported by various hotels. We understand there is limited supply of Class A office buildings due to high construction costs.

Our thoughts on the Centerpointe acquisition

  • Given the expected DPU accretion, we are generally positive on the acquisition. However, overall occupancy for the Fairfax submarket is relatively low, in the low 70’s which may be a medium-term concern. This is partially mitigated by the strong positioning of the property, as seen by occupancy being above 90’s over the past eight years and averaging 94%, as well as the long WALE of c.6.9 years.
  • Furthermore, Centerpointe has been able to command rental rates that are 10-25% above market. We understand the relatively high sub-market vacancy is due to several buildings in the area being of a lower quality and/or in the midst of being repositioned.
  • In addition, there is potential for the submarket to benefit from the establishment of Amazon’s second HQ in nearby Arlington.
  • We also understand due to rising construction cost, replacement value for Centerpointe stands around US$525 psf, compared to acquisition price of c.US$300 psf.

Enlarged portfolio worth US$1.9bn and 4-7% uplift to our FY19-21F DPU estimates

  • Post the acquisition of Centrepoint I & II, Manulife US REIT’s portfolio by value increased from US$1.7bn to US$1.9bn with total NLA rising from 3.7m sqft to 4.2m sqft.
  • Overall WALE by NLA and occupancy lifted marginally to 6.1 years and 97.6% from 6.0 years and 97.4% respectively.
  • We estimate post the acquisition of Centerpointe I & II, there will be 2-4% accretion to our FY19-21F DPU. However, after incorporating lower interest rates for debt due for refinancing over the next three years, (3.8% versus 4.5% previously) as our DBS economists are now forecasting two rate cut, we raised our FY19-21F DPU by 5-8%.
  • Likewise, we raised our DCF-based Target Price to US$1.00 from US$0.92 following the uplift from Centerpointe acquisition, rolling forward our valuation base to FY20 and assuming a new risk free rate of 2.5% in line with our new DBS economist’s forecast (3.0% previously). Our Target Price implies a P/Bk of 1.2x which we believe is fair considering the markets where Manulife US REIT’s properties are located are generally still healthy and Manulife US REIT should still deliver healthy DPU growth ahead.

Highlights from recent US site visit

Atlanta properties trading below replacement costs in strong office markets

  • Our recent visit to Manulife US REIT’s two Atlanta properties, Peachtree and Phipps, reemphasizes the potential uplift in capital values in a strong office market.
  • We understand with a large proportion of vacant land being converted into multi-family or residential apartments and rising construction costs, new office supply constraints combined with healthy demand is translating to healthy rental market growth.
  • The attractiveness of Atlanta for corporates is access to the educated millennial talent pool sourced from the three colleges in the area - Georgia Tech, Georgia State and Emory. Furthermore, the more affordable cost of living and cost of doing business compared to large gateway cities such as New York, is a major draw for corporates looking to relocate or expand in Atlanta. Likewise, this is drawing the people to Atlanta as seen as by the 40% plus increase in population over the last 10 years, one of the highest among large cities in the US.
  • In addition, due to rising construction costs and land, based on Cushman & Wakefield’s analysis, replacement costs for a new office building stands at c.US$525 psf. In comparison, based on the latest valuation as at 31 December 2018, Peachtree and Phipps are valued at US$325 and US$350 psf respectively.
  • For the Peachtree property, the attractiveness of the property to prospective tenants is expected to be enhanced by the addition of new retail space diagonally across the road and half a block away at Colony Square.
  • This combined with the current replacement costs, and rising rents gives us confidence that there is potential for uplift in property values over time on the back of rising office market. Therefore, Manulife US REIT deserves to trade at a premium to book as implied by our Target Price.

Strong market positioning in New Jersey

  • We also visited Manulife US REIT’s two New Jersey properties, Plaza at Secaucus and Exchange at Waterfront, New Jersey City. Key attributes present at the time of acquisition - walking distance to amenities and easy access via highways in the case of Plaza and public transport for Exchange (one train stop from Manhattan and directly opposite the PATH station) - remain in place.
  • For the Plaza, with the building close to fully occupied and vacancy rates for directly competing buildings at around 5%, there is potential for rents to head higher.
  • Exchange also has strong potential to command higher rents post the renovation of the lobby area. Near term, the market remains attractive for prospective tenants as the Waterfront, Jersey City area continues to offer value compared to rents in Manhattan. In addition, with the influx of new housing, employees and tenants can enjoy a work live play environment.
  • We also understand while overall market vacancy for the Waterfront precinct is high at around 18% according to Cushman and Wakefield, this is driven by vacancy at 101 Hudson which has blocked views from an adjacent new condominium. Furthermore, Mack-Cali which controls a large proportion of the office supply in the area is in the process of rejuvenating its properties including a refreshed retail amenity and is holding out for higher rents, resulting in vacant office space. The upgraded retail amenities at Waterside owned by Mack-Cali combined with the upgrading of the Exchange’s lobby and lift areas, should enhance the Exchange’s positioning and potentially translate to higher rents.
  • In addition, we understand that rents in Manhattan itself have been soft lately arising from the new offices at Hudson Yards which is first major new supply in Manhattan in the last few decades. This has caused existing office owners (average age of office buildings on Manhattan is c.50 years) to refurbish their buildings and offer greater incentives. Nevertheless, the rental gap between New Jersey and Manhattan remains wide at up to 50%, which imply that the Plaza and Exchange are attractive locations.

Maintain BUY with revised Target Price of US$1.00

  • Prior to the recent acquisition of Centerpointe I & II, we had assumed a modest DPU profile for Manulife US REIT following the jump in FY19 due to the two acquisitions made in FY19, as higher interest rates and dilution from management fee units would offset the impact of the 1-3% inbuilt rental escalations.
  • With a more dovish Federal Reserve which should translate to lower refinancing cost, and the boost from the expansion into Virginia, we now forecast a healthy 3-year DPU CAGR of c.4%.
  • Combined with the still positive market outlook, increased confidence over potential upside to capital values for Manulife US REIT’s properties and attractive 7.3% yield, we reiterate our BUY call with a revised Target Price of US$1.00.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | 2019-06-17
SGX Stock Analyst Report BUY MAINTAIN BUY 1.00 UP 0.920