US Office REITs - DBS Research 2019-06-17: US Still The Place To Be

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MANULIFE US REIT (SGX:BTOU) KEPPEL-KBS US REIT (SGX:CMOU)

US Office REITs - US Still The Place To Be

• Rising replacement cost supports our view that US office REITs should trade at a premium to book.
• Recent US site visits reaffirm positive rental outlook.
• Keppel-KBS US REIT / Manulife US REIT’s unique attributes should enable both REITs to perform despite recent macro concerns.
• Maintain BUY on Keppel-KBS US REIT (Target Price of US$0.90) and Manulife US REIT (Target Price US$1.00).

Still positive rental outlook.

• Recent discussions with property consultants reaffirmed healthy demand for office space supported by either
  1. strong individual property characteristics i.e. location or
  2. active property management via AEIs or usage of spec suites to drive tenant demand.
• This arose during our site visits to KEPPEL-KBS US REIT (SGX:CMOU) and MANULIFE US REIT (SGX:BTOU)'s properties in Atlanta, Austin, Houston, New Jersey, and Seattle.
• The healthy demand should translate to higher rents and with in-place rents for both Keppel-KBS US REIT and Manulife US REIT generally below market (5-20%), resulting in positive rental reversions and higher DPU ahead.

Premium to book justified.

• During our site tours, a consistent theme was how rising construction costs driven by a tighter labour market restricts new supply growth. Furthermore, with available land being utilised for residential use results in high replacement costs for office buildings and capital values.
• Combined with expectations of rising rents ahead, we believe Keppel-KBS US REIT and Manulife US REIT should trade above book value at 1.15-1.20x as implied by our Target Price of US$0.90 and US$1.00 respectively.

Share prices to perform on the back of robust DPU growth.

• Despite recent growth concerns arising from current trade tensions, we believe Keppel-KBS US REIT’s share price and Manulife US REIT’s share price can perform as they are projected to deliver healthy 5-8% 3-year CAGR DPU growth on the back of
  1. acquisitions made over the past year,
  2. in-built annual rental escalation of 1-3% and
  3. tailwinds from the upturn in rents.
• Furthermore, Keppel-KBS US REIT is positioned in markets with higher than average growth arising from strong population growth and corporate relocations. Its presence in Seattle and Austin (c.61% of the portfolio) where rents have jumped by up to 20% y-o-y in 1Q19 also provides exposure to the growing US tech sector.
• Additionally, Manulife US REIT is a beneficiary of a long WALE of c.6 years and in-place rents generally 5-10% below market.
• Finally, we believe the share prices of both REITs should benefit from expectations of lower interest rates with two rate cuts by the Federal Reserve in 2019 as projected by our DBS economists to mitigate downside risk to economic growth. Thus, we reiterate our positive stance and BUY calls on Keppel-KBS US REIT (Target Price US$0.90) and Manulife US REIT (US$1.00).
• See reports:
  • Manulife US REIT - Positioned To Rally Further
  • Keppel-KBS US REIT - Unique Beneficiary Of US Technology

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2019-06-17

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