Manulife US REIT - DBS Research 2020-03-25: Stronger Than You Think

MANULIFE US REIT (SGX:BTOU)

Manulife US REIT - Stronger Than You Think

Manulife US REIT (SGX:BTOU)’s management believes its portfolio, comprising Class A/trophy assets, strong top 10 tenant profile and a good set of credit metrics, is stable and resilient to weather the short-term pain and potential recession.
While it is still early stages of the COVID-19 outbreak in the US, management expects leasing activities and the transaction market to slow down as tenants/buyers/sellers take a wait-and-see approach.

Management does not expect refinancing risks at the moment and credit metrics still provide some debt headroom.
While valuations look attractive at price levels between 55 US Scts and 61 US Scts, share price could remain volatile as it trades in tandem with the US market/and sentiment on its economy.

Manulife US REIT (SGX:BTOU) organised an update call on the morning of 24 March 2020 to address the numerous questions on the impact from the current situation and to give further comfort on the resilience of its portfolio.
In summary, Manulife US REIT’s management believes that its portfolio remains resilient amid the current headwinds following the COVID-19 outbreak. As it is still early stages in the US (only one week of lockdown/movement restriction measures being implemented), management expects leasing activities to slow down as existing/prospective tenants take a wait-and-see approach.
Management’s base-case expectations are a sharp downturn in 1H2020 and potentially a sharp rebound when the COVID-19 situation stabilises in 2H2020. As such, management believes that its portfolio, comprising Class A/trophy assets, strong top 10 tenant profile and a good set of credit metrics, is stable and resilient to weather the short-term pain and potential recession.
After a 48% drop from its peak in Jan 2020 to its lowest level just yesterday, Manulife US REIT Share Price has rebounded by 11% today (as of time of writing).

Management believes that the possible reasons for the sharp drop could be segregated into three groups as follows:
1. following the index inclusion at end-2019, Manulife US REIT’s shareholder base has improved to include large funds such as pension funds. Sell-off positions from these funds possibly led to the sharp drop in prices,
2. margin calls from HNW investors especially HNW Chinese individuals. However, Manulife US REIT’s management reassured that there were minimal HNW Chinese individuals in its register,
3. fund redemption or repositioning.
Majority of Manulife US REIT’s shareholders are institutional investors. Manulife US REIT’s shareholders comprise 60% institutions and 40% individuals.

Given that most corporates have implemented work-from-home arrangements, the current occupancy in the office buildings are below 20%, thus reducing risks of a potential COVID-19 case in the office buildings and also staffing needs. F&B retail outlets, which contribute only 1% of portfolio income, are now temporarily closed.

Rental rebates are not offered to office tenants, not even during the GFC. However, Manulife US REIT is looking to provide some form of help for its F&B tenants (a very small portion of the portfolio) on a case-by-case basis. Manulife US REIT highlighted that the pandemic does not qualify for business interruption insurance.

The security deposits collected from Manulife US REIT’s tenants ranges from zero to four months, based on the credit profile and length of tenant relationship with Manulife US REIT. Typically, landlords (Manulife US REIT) will make a decision whether to classify a tenant as ‘default’ if rent payments are 60 days in arrears.
Majority of (seven out of nine) Manulife US REIT’s assets are Class A assets which are more resilient. According to management, Class A assets are typically more attractive and resilient during a recession. In addition, Class A assets tend to benefit from a potential flight to quality if rental rates look attractive. The majority (seven out of nine) of Manulife US REIT’s assets are Class A assets while the remaining two are trophy assets.
During the GFC, occupancy dropped to between 80% and 90%; valuers may remain “sticky” due to lack of transactions. As a point of reference, occupancies at Figueroa, LA and Peachtree, Atlanta fell to c.90% and c.80% during the GFC. Management expects valuers to remain “sticky” and be more reactionary given the expected lack of transactions as most buyers and sellers would take a wait-and-see approach.

While there are comments that there could be a structural shift of tenants right-sizing their office space needs with a more flexible working arrangement moving forward, management believes that the structural change is minimal and their top 10 tenants have either right-sized recently or are unlikely to change as many of the corporates in the US would have existing flexible work arrangements.
Management does not expect refinancing risks but possibly some interest savings from lower interest rates; sufficient undrawn debt facilities. As there is limited refinancing in FY2020, management does not expect any refinancing risks, but there could be some interest savings from lower interest rates.
In addition, unencumbered debt will likely improve to 41% from 34% currently, post refinancing. Undrawn debt facilities stood at US$290m comprising US$90m of RCF and US$200m of lines for acquisition. ICR as at Dec 2019 stood at 3.8x vs debt covenant of 2x. Based on management’s stress testing of its cashflow needs, EBITDA needs to fall by > 50% (c.US$60m) before the ICR is triggered.

Manulife US REIT expects payout ratio and management fee in units to remain status quo.

Rachel TAN DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-03-25

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