US Office REITS - RHB Invest 2020-08-19: Well-Poised To Weather COVID-19 Challenges

MANULIFE US REIT (SGX:BTOU) KEPPEL PACIFIC OAK US REIT (SGX:CMOU) PRIME US REIT (SGX:OXMU)

US Office REITS - Well-Poised To Weather COVID-19 Challenges

Although COVID-19 infections continue to rise sharply in the US, Singapore-listed US office REITs posted robust 1H20 results, with positive operating metrics. Concerns remain on the sustainability of this growth, but our comparison shows all three REITs should be able to weather headwinds – backed by asset diversification, long WALE, and healthy balance sheets.
Valuations are cheap, with segmental yields averaging 8.3%, or 280bps higher than office S-REITs.
Maintain sector OVERWEIGHT; BUY Manulife US REIT (SGX:BTOU) and Keppel Pacific Oak US REIT (SGX:CMOU).

All three US office REITs (including Prime US REIT (SGX:OXMU), which is not in our coverage) posted higher 1H20 DPU, as rental escalations, stable occupancy rates, and acquisition contributions more than offset rental deferments and lower carpark income. See Figure2 in PDF report attached below for 1H20 result scorecard of US Office REITs. See also Keppel Pacific Oak US REIT Dividend History, Manulife US REIT Dividend History, Prime US REIT Dividend History,
Rental collection for 2Q20 was also healthy at 92-99%, with minimal abatements.
Our discussions with REIT managers confirm that, despite COVID-19, requests for additional rental abatement/deferrals have been minimal, as properties were still operational. Lease expiries for all three REITs also remain low at c.3%. This, together with healthy rental collection, leads us to expect stable DPU for 2H20.

Gearing for all three US office REITs remains < 40% (well below 50% threshold), with Prime US REIT’s being the lowest, at 33% and with the longest debt maturity of 5.1 years.
With financial market conditions being more favourable now, coupled with depth in US office market and sponsor strength presenting opportunities, the likelihood of acquisitions in 2H20 is high. Note that the majority of office leases in the US have in-built rental escalations of c.2-3%, which provides organic DPU growth.

Manulife US REIT cited recent studies showing that the WFH trend had been quite prevalent even before the COVID-19 pandemic, with 54% of employees in the US having access to such benefits. It also shared that, based on new surveys, only 12% of employees prefer the WFH option vs 10% prior to the pandemic.
While leasing activities have slowed down, the latest JLL report indicates that demand is supported by the tech and finance sectors, with larger leases mainly from government, health, and health insurance.
In our view, the impact of flexible office space is likely to pare down long-term demand (~5%) – but this may be partially offset by de-densification trends and moderate supply, which has been further pushed back.

US office REITs’ WALE periods are long (c.4-6 years), with Manulife US REIT having the highest, at 5.7 years. Tenants are also well-diversified with no sector accounting for > 30% overall, and no single tenant occupying > 10% for all three REITs. See Figure1 in PDF report attached below for comparison of the 3 US office S-REITs - Prime US REIT (SGX:OXMU), Manulife US REIT (SGX:BTOU) and Keppel Pacific Oak US REIT (SGX:CMOU).
In-place average rentals for REITs are also below rates for Keppel Pacific Oak US REIT (c.10.8% lower), Prime US REIT (c.7.5% lower) and Manulife US REIT (-19% to +1%, ex-Centerpointe and Michelson, which have above-market rates).
See also recent SGX market update: 1H2020 Earnings of SGX’s 3 Largest US-Focused REITs.
Key risks are a prolonged economic downturn, collapse of co-working office players, and policy uncertainties from the upcoming US election.

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2020-08-19

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