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


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.
  • Maintain BUY on valuation grounds with a target price of US$0.85.

US return-to-office play.

  • 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

  • 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

  • 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%.

Portfolio proving resilient, amid escalated risks of COVID-19 headwinds.

  • 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.

Beneficiary of rotational interest.

  • 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).

Outlook: The future of office demand in the US.

  • 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.

US office sector may also be near inflection point.

  • 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 Manulife US REIT

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