Manulife US REIT - UOB Kay Hian 2020-07-21: US Return-to-office Play

MANULIFE US REIT (SGX:BTOU)

Manulife US REIT - US Return-to-office Play

Manulife US REIT (SGX:BTOU) trades at an undemanding valuation of 8.5% forward yield (ie 330bp above Singapore peers), despite its freehold and Trophy/Class A properties. Although we like its superior assets, long WALE and locations, we are increasingly cognisant of tailwind risks from a secular shift in office demand − a delayed re-opening may lead to lasting flexi work policies by some companies which may reduce their square footage of office space.

As US states navigate their re-opening, companies will eventually bring back at least some office workers, who have been working remotely. Some major employers, Facebook (from 6 Jul 20), Google (from 8 Sep 20), and Amazon (from 8 Jan 21) will begin reopening their US offices in a gradual, phased approach. Higher gross leasing volumes are also expected in 2H20 according to JLL with resumption of more space tours, both in person and virtual.

Stable-income and pay-out profile underpinned by superior assets, credit tenants, long WALE and locational strengths. Manulife US REIT’s US$2.1b portfolio comprises nine prime, freehold and Trophy (2)/ Class A (7) properties which provide strong income in upcycles, but remain resilient during downturns as compared to lower class assets.
Management observed from past crises, higher quality properties continue to see leasing demand from surviving Class B tenants, which try to take advantage of the more affordable rents.
Manulife US REIT has a diversified tenant base (182 tenants), of which over 60% are in reliable trade sectors (eg government, legal, finance, technology, and healthcare).

Manulife US REIT has a relatively longer WALE of 5.7 years by NLA, when stacked up against that of other S-REITs in the office space, such as Keppel Pacific Oak US REIT (SGX:CMOU) (5.3 years), Keppel REIT (SGX:K71U) (4.7 years), CapitaLand Commercial Trust (SGX:C61U) (Office: 3.7 years), Suntec REIT (SGX:T82U) (SG office: 3.26 years). A relatively longer WALE offers stronger income visibility (and distribution stability).
The US is also a different market compared with Singapore, where office leases are usually longer at 5/10/15 years (vs Singapore norm: 3-years) with no break clauses, and early-terminations which can result in severe financial penalties.
Manulife US REIT’s properties tend to be located near amenities and growing residential developments outside of CBDs, but still prestigious city, urban, and suburban locations. Despite many S-REITs cutting distributions, Manulife US REIT indicated their preference to continue paying out 100%.

A majority (98%) of Manulife US REIT’s 181 tenants paid their Apr 20 rents, although the rent deferrals (2%) may increase closer to 10% in May and Jun 20. Manulife US REIT has minimal exposure to tenants from sectors adversely affected by COVID-19, such as travel, hospitality, leisure, airlines and oil & gas.
Management has requested tenants seeking deferment to seek help from government schemes, banks, and provide hardship proof. Even as the US moves to a “Return to Office” phase, management acknowledged that some sectors may take a longer recovery route.
All nine of Manulife US REIT’s buildings remained opened throughout the outbreak with physical occupancy in the 10-20% range in May 20 but this is expected to gradually increase as the “return-to-office” comes underway. Although Manulife US REIT has implemented additional health and hygiene measures (eg special HVAC air filters (MERV 13), regulating humidity and air-circulation, new UV cleaning machines), these extra operating costs can be passed on to tenants under many of Manulife US REIT’s leases.

Manulife US REIT has an undemanding valuation (8.5%), compared with many Singapore office peers (Keppel REIT (SGX:K71U): 5.0%; Suntec REIT (SGX:T82U): 6.7%; CapitaLand Commercial Trust (SGX:C61U): 4.0%), despite the latter holding mostly leasehold properties. Unlike Singapore (c.326% of 2018 GDP), the US economy has lower trade openness (c.28% of 2018 GDP) and is less susceptible to a post-COVID world where movement of people and trade across borders become more restricted.
Manulife US REIT is a proxy on the more resilient US GDP growth and its commercial segment. UOB Global Economics & Markets Research expects q-o-q GDP rebounds for the second half of the year (+16.5% in 3Q20 /11.7% in 4Q20).

Management alleged that unlike in Asia, flexi-working (incl. Work-From-Home (WFH)) has been a norm in the US for over a decade, and has been especially popular with the media, arts and technology-related companies. They also continue to believe in the value-proposition of office spaces, in terms of efficiency/productivity, face-to-face contact for deal making, and functionality as a HQ for decision-making.
According to JLL, new ground breakings will likely be minimal as construction lending tightens. Management has expressed similar views, which will keep the limited supply of Class A/Trophy space in check and support office rental growth.

After US gross leasing volumes posted a steep 53% decline in 2Q20, from shelter-in-place orders, wait-and-see decisions by occupiers, and additional time spent on negotiating critical lease components, JLL expects some degree of rebound in 2H20 (ie with easing timelines for occupiers to execute leases).
While JLL’s commentary refers to the overall US office market, we believe similar leasing dynamics are in play in Manulife US REIT’s Class A submarkets. In the near term, though, only a minimal 4%/6.1% of Manulife US REIT’s NLA is due to expire in 2020 (ie mainly in 2H20) and 2021 respectively.

Maintain BUY on valuation grounds with a target price of US$0.85, based on DDM (required rate of return: 8.0%, terminal growth: 1.0%). Manulife US REIT currently offers a forward yield of 8.4% (which is 1.1SD above historical mean), and may be relatively insulated in the near-term due to its lease structure, quality assets, and locations.
In the longer term, we are concerned about softening US office demand from a possible secular shift (not only cyclical weakness). A slower-than-expected re-opening of the US economy increases the likelihood of more companies leaning towards lasting-flexi work polices that reduces their square footage of office spaces.
See Manulife US REIT Share Price; Manulife US REIT Target Price; Manulife US REIT Analyst Reports; Manulife US REIT Dividend History; Manulife US REIT Announcements; Manulife US REIT Latest News.
Manulife US REIT's share price catalysts:
- Positive news flow on office leasing activity.
- Reduction in infection rates of COVID-19 in the US.

Peihao LOKE UOB Kay Hian Research | Jonathan KOH CFA UOB Kay Hian | https://research.uobkayhian.com/ 2020-07-21

SGX Stock Analyst Report BUY MAINTAIN BUY 0.85 DOWN 1.070