Keppel Pacific Oak US REIT - DBS Research 2019-09-09: Hello Dallas


Keppel Pacific Oak US REIT - Hello Dallas

  • Proposed acquisition of One Twenty Five Class A complex for US$105.2m in Dallas from Sponsor.
  • Quality micro market dynamics points to stronger prospects in the long term.
  • Under-rented property with long WALE; adds diversity and defensiveness to Keppel Pacific Oak US REIT.
  • Proposed transaction underscores Keppel Pacific Oak US REIT’s ability to still tap on Sponsor; continues to have right of first refusal on potential divestments by KBS Strategic Opportunities REIT I&II despite name change.

What’s New

  • KEPPEL PACIFIC OAK US REIT (SGX:CMOU) (previously known as Keppel-KBS US REIT (SGX:CMOU)) announced the acquisition of One Twenty Five Class A office Complex in Irving, Dallas, Texas for a total cost of US$105.2m.
  • One Twenty Five is a freehold office complex comprising two Class A office buildings - 125 East John Carpenter and 5100 North O’Connor - with a total NLA of 445,317 sqft.
  • The property is located in the office submarket of Las Colinas within Dallas which management believes is one of the top office submarkets within Dallas.
  • Capital improvements have been made since 2015 to upgrade the property, enabling the property to remain competitive and relevant to tenants’ needs.
  • Initial yield is estimated to be c.7.0%, which compares favourably against portfolio yield of c.6.5%.
  • The vendor of One Twenty Five is KBS Strategic Opportunities REIT I&II.

Stable macros supporting demand in Las Colinas, Dallas.

  • Dallas remains one of the stronger cities within the US, enjoying strong GDP growth of 4.2% (vs US average of 2.2%) during 2013-2017, and stable growth of 3.1% going forward.
  • The city has one of the highest concentrations of corporate HQs in the US, with a desirable work-live-play environment.
  • Growth in the office market in Dallas is also supported by strong population growth, which is expected to grow by 19.7% through to 2025.
  • Supported by young, affluent and well-educated population and low unemployment rates, we believe that the property is located in a fundamentally strong market.
  • One Twenty Five is located within one of the top submarkets in Las Colinas, which has an office inventory of 6.6m sqft and limited completions in the future.
  • The opening of The Music Factory, a mixed-use office plus entertainment development, has improved amenity options for occupiers and tenants within Las Colinas.
  • Given limited supply, overall vacancy rates have dipped to 13.0% (2Q19) from 25.5% in 2009 in Las Colinas. This is well below the average vacancy of 19.3% for Dallas.
  • With strong absorption trends, rentals in Las Colinas have also risen significantly from US$22.10 psf in 2009 to US$29.74psf in 2018, representing CAGR of 3.4%, outpacing the 2.9% growth in rents for Dallas. Rents are expected to continue to remain on an uptrend, rising by 1.5% CAGR during 2019 to 2024 to US$32.57psf, given strong leasing demand coupled with lack of new supply.

Improves Keppel Pacific Oak US REIT’s tenant diversity and defensiveness; an under-rented property with upside when leases are up for renewal.

  • One Twenty Five will be acquired at an initial yield of c.7.0%, supported by a long weighted average expiry (WALE) of 7.1 years, and is leased to 20 tenants, mainly in the professional service, government service, medical and healthcare industries.
  • Property occupancy rate is high at 95.5%, and there is further upside if the empty space is taken up by third parties or there is expansionary demand from existing tenants.
  • The top 5 tenants (c.55% of revenue) has an even longer WALE of 8.5 years by NLA, offering strong income visibility.
  • We believe that the new tenant exposure adds diversity and defensiveness to the overall portfolio, reducing its reliance on any tenant or industry.
  • The in-place rents for the property is US$25.72 psf, which is estimated to be 10.7% higher than the comparable market rent for similar competitive buildings.
  • The Manager targets to lift rental rates higher when as leases fall due in the medium term.

Accretive deal; improves leverage and debt capacity

  • Based on pro-forma estimates provided by the Manager, the acquisition is expected to be funded by a combination of equity (65%) and new debt (35%) at an assumed cost of debt of c.3.0%. This is expected to result in a c.1% rise in DPU while gearing is expected to dip marginally to c.35%.
  • No change to our estimates and our BUY call, pending completion of the deal.

Keppel KBS US REIT (KORE) changes its name to Keppel Pacific Oak US REIT (KORE).

  • Keppel Pacific Oak US REIT will be entering into a new outsourcing management agreement with Pacific Oak Capital Advisors LLC, to be engaged as the Manager.
  • The current Core Plus Team that provides asset management services under the current service agreement will be employed by the new US manager.
  • The Management agreement with Pacific Oak Advisors LLC will be substantially on the same terms as the current KBS Management Agreement.
  • The team will continue to source for acquisitions in choice markets for Keppel Pacific Oak US REIT.
  • The name change and branding signify a parting with the former KBS brand.

Our thoughts.

  • Pacific Oak was formed in 2018 and co-founded by Keith Hall and Peter McMillian, the original founders of KBS Capital Advisors and KBS Capital Markets Group.
  • Notwithstanding the re-organisation, it is envisioned that the Core Plus team will continue to provide asset management services to the REIT, and at the same time, will be employed by the new US Asset Manager.
  • We understand that there is no change to the current arrangement where Keppel Pacific Oak US REIT will continue to have the first look at (or right of first refusal) on any potential asset divestment by KBS Strategic Opportunities REIT I&II.
  • The name change and parting of the relationship with KBS would provide clarity to investors given that there have been questions raised on the close relationships and investment mandates with Prime US REIT (SGX:OXMU), which is also sponsored by another entity of KBS.

Derek TAN DBS Group Research | Rachel TAN DBS Research | 2019-09-09
SGX Stock Analyst Report BUY MAINTAIN BUY 0.90 SAME 0.90