Manulife US REIT - UOB Kay Hian 2020-08-04: 2Q20 Riding Through COVID-19

MANULIFE US REIT (SGX:BTOU)

Manulife US REIT - 2Q20 Riding Through COVID-19

Manulife US REIT’s ability to ride through the pandemic hinges on its long WALE (5.7 years), occupancy (96.2%), and diversified tenant base. Management continues to downplay any negative impact from COVID-19 and WFH trends on office demand-supply dynamics, while seeing a potentially faster US recovery (vs GFC).
Maintain BUY with unchanged US$0.85 target price.

Manulife US REIT (SGX:BTOU) reported 1H20 DPU of 3.05 S cents (+0.3% y-o-y), while distributable income grew 20%yoy. 1H20 gross revenue and NPI were both up 18.3% and 18.8%% y-o-y, largely due to contributions from Centerpointe and Capitol acquired in FY19, partially offset by lower rental income from Michelson and lower portfolio carpark income.
1H20 DPU forms 51% of our full-year forecasts.

Signing leases (~217,300sf NLA/4.7% of portfolio NLA) came mainly from the finance and insurance, legal, real estate and tech tenants, and were executed with 6.9 years WALE and rental escalation of 2.4% p.a., comprising renewals (50%), new (42%) and expansion leases (8%). Some 96% of leases by GRI have rental escalations, while remaining 4% (82% of which are government leases) do not.
Manulife US REIT’s passing rents are competitive (passing rent 5-10% below market mostly) and provide a buffer for positive reversion.

Portfolio occupancy grew marginally to 96.2% (+0.4ppt h-o-h), mainly attributable to increases at Peachtree (+3.3ppt h-o-h). Manulife US REIT’s Best-in-Class properties have also exceeded respective market occupancies (except for Sacramento).
Full occupancies were attained in Buckhead Atlanta (Phipps) and Washington DC (Penn). Overall, MUST’s portfolio of 96.2% compares favourably to the 89.9% US average.

In 1H20, investment properties recorded a net fair loss of US$77.3m, due to the appraiser factoring in lower rental growth assumptions as a result of the COVID-19 pandemic, adjusted for capex and other costs relating to investment properties.
Overall, cap rates still remained relatively stable at 5.6% (-0.1ppt h-o-h), while property valuations declined 2.9% h-o-h. Management expects the valuation decline to reverse, once COVID- 19 pandemic subsides.
Manulife US REIT also has a well-spread debt maturity profile with no debts due in 2020, after its US$100m maiden Green loan re-financing at 1.85% in Jul 20. At end-Jul 20, Manulife US REIT also increase its weighted average debt maturity to 2.8 years (+22%).

Manulife US REIT has only minimal expiries in 2020 (3.4%) and 2021 (5.7%) by NLA. The US office market is also different compared with Singapore, where office leases are usually longer at 5/10/15 years (vs Singapore norm of 3 years) with no break clauses, no early terminations, although US office tenants can sub-lease spaces. Anecdotally, management has not seen any discernible increase in sub-leasing by its tenants, suggesting their high quality.
Manulife US REIT’s inorganic growth to nine properties has diversified its tenant base to 17 trade sectors. Among its largest trade sectors by gross rental income (GRI), Legal trade (22%) is unlikely to see consolidation as majority of its tenants have right-sized, followed by Finance and Insurance (19.9%) which may see an increase in its take-up due to stricter social distancing, and finally, the Retail Trade (13.5%) that mainly comprises tenants in children’s apparel, which is an essential sector.

Only three of Manulife US REIT’s submarkets have upcoming supply, beginning with Buckhead Atlanta (340,000sf/2021) that is unlikely to have much impact on Phipps as it is 100% leased with 7.6 year WALE. Midtown Atlanta (679,000 sf/2021) has been 40% pre-leased by Google and has an asking rent that is 80% higher. The supply in Washington, D.C. (482,000sf/2022) is not comparable to Penn (Class A) as they are Trophy grade with asking rents that are 20% higher.

Management alleged that unlike Singapore, Work-From-Home (WFH) has been introduced to the US since the 1990s; 54% of US workers are entitled to WFH benefits as at 31 Mar 20. Hence, only an incremental 2% of US workers prefer to WFH full-time due to the COVID-19 pandemic.
A physical office continues to be essential for the company’s branding and culture, which drives employee connectivity, engages/attracts talent, and increases productivity. Manulife US REIT’s top trade sectors (IT, Insurance, Healthcare, Legal, and Finance) were early adopters of WFH. The pandemic also means a delay in workers returning to dense gateway CBD offices, in contrast to Manulife US REIT’s urban suburban offices.
Supply is likely to be kept in check, due to limited bank loans for developments and pre-leasing requisite for new construction starts. The pandemic means incremental space required for social distancing, while the new normal WFH/WFO combination still requires designated workspaces and does not reduce office demand.

All nine of Manulife US REIT’s offices are currently 10-20% physically occupied as not all workers have returned to work from office due to a rising number of COVID-19 cases. Despite rent collection appearing to come down (ie Apr/May/Jun at 99%/97%/93%), management explained that tenants are only taking more time to pay.
Management sees a swift recovery compared to GFC, as banks are better equipped to maintain market liquidity, have less levered commercial real estate, less oversupply of inventory, and ~90% of US office leases have a lease balance over two years that can weather short-term impacts.

Peihao LOKE UOB Kay Hian Research | Jonathan KOH CFA UOB Kay Hian | https://research.uobkayhian.com/ 2020-08-04

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