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US Office S-REITs - DBS Research 2021-03-12: Captain America Strikes Back

US Office S-REITs | SGinvestors.io PRIME US REIT (SGX:OXMU) KEPPEL PACIFIC OAK US REIT (SGX:CMOU) MANULIFE US REIT (SGX:BTOU)

US Office S-REITs - Captain America Strikes Back

  • Looking ahead to US recovery, sped up by vaccination and stimulus package.
  • Rotational interests into risk-on/recovery plays could drive the next leg of re-rating.
  • We believe the US Office S-REITs will be able to weather potential occupancy headwinds in the near term with a more resilient regional office portfolio and low expiring leases in FY21.
  • US Office S-REITs currently trades at ~9% yield and yield spread of ~7%, still offering deep value.



Looking ahead to US recovery, sped up by vaccination and stimulus package

  • The US had a tough year in 2020 battling the COVID-19 pandemic. While some Asia countries have seen a glimmer of hope such as China, which has led the recovery, the number of COVID cases in the US had remained high throughout 2020.
  • However, the outlook on the US economy has turned and gained much optimism as economists up their forecasts and expect recovery to be quicker and stronger than expected. These were led by 3 key factors:
    1. Vaccination rate could be faster than expected and may speed up the country’s return to normalcy
    2. Job data has been heading in the right direction towards recovery, which has been encouraging
    3. US$1.9tr stimulus package to boost the US economy

Vaccination has significantly reduced the number of new cases in the US.

  • With the discovery of the COVID-19 vaccine in October 2020 and the successful roll-out subsequently, the number of new cases per day in the US has fallen significantly from the high of close to 300k cases in January 2021 to the latest figure of ~60k cases per day. Compared to other countries (top 14 countries by GDP), the US no longer top the charts based on the new cases per day per million population and has fallen outside the top 3.

Rate of vaccination has been faster than expected, second fastest among the top 15 countries by GDP.

  • Vaccination has progressed swiftly in the US which boasts the second highest rate of vaccination (total vaccines per 100 population) only behind the UK among the top 15 countries by GDP. According to Bloomberg and Our World in Data, 93.7m doses have been given out in the US and an average of 2.15m doses per day were administered in the past week.

Additional 100m doses of J&J vaccine ordered could speed up the vaccination rate further and return to normalcy earlier than expected.

  • According to Bloomberg, based on the vaccination rate of 2.15m doses per day, the US is estimated to take six months to cover 75% of its population with the two-dose vaccine. This is within the range of 70-85% of the population to be vaccinated for the country to return to normalcy, according to Anthony Fauci, the top infectious-disease official in the US.
  • With the single-shot vaccine by Johnson & Johnson (J&J) having been approved by the FDA (third vaccine approved) recently and as President Biden is procuring another 100m doses (doubling his previous order), we believe the vaccination rate could speed up further for the country to return to normalcy earlier than expected.

Macroeconomic data pointing towards recovery and readiness to surge with big stimulus.

  • The latest macroeconomic data released by the US in 1Q21 is encouraging. Jobless claims have been below expectations, US nonfarm payrolls in February 2021 surged to 379k, beating the market expectation of 182k by a huge margin, and the latest unemployment rate in February 2021 continued to edge lower to 6.2%, though marginally from 6.3%. Given the anticipation of the US$1.9tr stimulus bill,
  • OECD (Organisation for Economic Co-operation and Development) has hiked its US economic growth forecast to 6.5% from 3.2% previously. Similarly, our chief economist has upgraded this year’s US growth forecast to 6% from 4.5% previously. Our economists believe that the Fed is likely to upgrade its growth outlook at its next FOMC meeting on 17 March.


Rotational interests into risk-on/recovery plays could drive the next leg of re-rating

  • As we compare how US Office REITs and US Office S-REITs have been trading, we note a few key points below which show that US Office S-REITs remain attractive at current levels.
    • US Office REITs saw their share prices trending upwards since the discovery of COVID-19 vaccine as investors rotate to risk-on/recovery plays.
    • US Office REITs with regional office portfolios are more resilient and outperformed those with gateway offices.
    • US Office S-REITs vs US Office regional office peers spread has widened to 2.4ppts vs historical average of 0.93ppt.
    • US Office S-REITs currently trade at 8.8% yields and yield spread of 7.3% which is above +1 standard deviation of their respective historical average.
    • Despite pricing in both a 10% cut in estimates and US 10-year bond yields rising to 2%, the yield spread of 5.5% is at historical average.
  • The rotational interests into risk-on/recovery plays as seen in the US Office REITs could drive the next leg of re-rating for the US Office S-REITs.

US Office REITs’ share prices have trended upwards since the discovery of COVID-19 vaccine and appear less impacted by the recent interest rate hike.

  • Given the recent hike in the US 10-year bond yields, we note that the US Office S-REITs have declined ~5% from their recent peak in January 2021, trending in line with the rest of the S-REITs. In contrast, we note that the share prices of the US Office REITs have been on an upward trend since the discovery of COVID-19 vaccine was announced in October 2020 as investors rotate into risk-on/recovery plays.
  • Despite being a laggard initially, share prices of both US and US Office regional office peers are at similar levels when compared to pre-COVID levels and have re-rated close to 80% of pre-COVID levels. Among the US Office S-REITs,

US Office REITs with regional offices are more resilient and outperformed those with gateway offices.

  • Interestingly, we also note that the US Office REITs with a larger regional office portfolio have outperformed the US Office REITs with a gateway office portfolio. This implies that the regional office segment appears to be more resilient throughout the COVID-19 pandemic while gateway office portfolio has seen some hollowing out of office space and increase in sublease market.

US Office REITs’ FFO yield has tightened as investors rotate into risk-on/recovery plays and regional offices trading at tighter yields.

  • Similar trends were observed in the FFO yield (funds from operations per share as a percent of the share price) of the US Office REITs. The US Office REITs had been a laggard until the vaccine was discovered. US Office REITs with a regional office portfolio are trading at a tighter FFO yield compared to those with a gateway office portfolio.

US Office S-REITs vs US Office regional office peers spread has widened to 2.4ppts vs historical average of 0.93ppt.

  • Based on the historical trends, US Office S-REITs typically trade at a higher yield vs the US Office peers’ FFO yield. Given the diverging trends between the US Office REITs vs the US Office S-REITs recently, we compared the US Office REITs vs the US Office regional peers and note that the yield spread between the two has widened to 2.4ppts vs historical average of 0.9ppt.

US Office S-REITs trading at attractive yields, at ~9% yield, above the sectors’ +1 standard deviation.

  • The US Office S-REITs continue to trade at attractive yields, at ~9% yield, above the sector’s +1 standard deviation of its historical range. On a P/NAV basis, the US Office S-REITs are trading close to 1x P/NAV, at their historical average.

Yield spread at ~7.3%, above +1 standard deviation of historical range and remains attractive despite bond yields hitting 2%.

  • Despite the rise in US 10-year bond yields to above 1.5%, the US Office S-REITs’ yield spread remains wide and attractive at ~7.3%, above +1 standard deviation of the historical range. If the US 10-year bond yields hits 2%, at current yield levels, the US Office S-REITs’ yield spread would still remain healthy at ~6.8%, close to +1 standard deviation of historical range.

Despite a 10% cut in distributable income, yield spread would remain above historical average of 5.5%.

  • Based on a ballpark estimate of a 10% cut in distributable income (potential impact from higher levels of flexible work arrangements), we estimate that the US Office S-REITs would trade at above 7.5% yield. As such, the yield spread is estimated to be ~5.5-6% (assuming US 10-year bond yields at 1.5% and 2% respectively), which is still at and above historical mean.


US Office S-REITs to overcome near-term occupancy headwinds with a more resilient regional office portfolio and low expiring leases in FY21.

  • The overall US office market has displayed subdued leasing data and market operational metrics and it is unsurprising that the cautious outlook had caused an overhang in the office sector until the discovery of vaccine resulted in newfound cautious optimism. However, we highlight some silver lining and positive factors for US Office S-REITs that could overcome the near-term headwinds and ride on the optimism of the US economic recovery.

Subdued leasing and high vacancy in overall US office market lead to cautious outlook.

  • Given that the majority of the US companies had continued with remote working arrangements throughout 2020, the US office leasing has remained heavily subdued since the pandemic hit in early 2020 with limited leasing, return of space, occupancy loss and rising vacancy.
  • According to CBRE, the overall US office market saw three quarters of negative absorption since 2Q20 totalling 80.1m sqft, which surpassed the 46.4m sqft incurred during GFC (global financial crisis). Office vacancy rate hit a high of 15% in 4Q20, the highest since 2013 while sublease activity increased to 3.4%, the highest level since 2004.

Rising trend of hybrid working model but survey implies up to only 30% impact.

  • In addition, the rising trend of hybrid working model but in varying degrees, could persist post pandemic. This could lead to some rationalisation of workspaces among office tenants and imply a longer period of muted office leasing. However, based on surveys conducted by PWC and McKinsey, the impact could be smaller than expected.
    • According to the survey conducted by McKinsey, the potential share of time working remotely without any productivity loss in advanced countries is estimated to be 28-30%. In addition, it is found that only 22% of the US workforce are able to work remotely for 3-5 days a week without affecting productivity, while 61% of the workforce can only work remotely for not more than a few hours a week.
    • According to PWC’s survey, ~70% of employers expect employees to work in office (WFO) at least three days a week while only 5% of employers feel that 100% remote working is viable. In addition, ~70% of the employers expect to require similar or more office space post COVID-19.
  • As such, based on both surveys, it appears that the impact of remote working is likely to be up to only 30%.

Silver lining for the US Office S-REITs to overcome near-term headwinds and to ride the optimism on the US economic recovery.

  • However, amid the bleak environment, we see a silver lining that could be positive for the US Office S-REITs’ portfolio to overcome the near-term occupancy headwinds and to ride the optimism on economic recovery in the US.
    • The optimism that the US could return to normalcy quicker than expected with the accelerated vaccination rate could raise sentiments a notch higher, leading to normalisation of leasing momentum.
    • The suburban office markets have remained more insulated and less impacted by negative absorption compared to downtown markets, according to CBRE. This bodes well for the US Office S-REITs’ portfolio that comprises largely suburban office markets rather than gateway city office buildings.
    • The US Office S-REITs have maintained occupancy at relatively healthy levels in FY20 and above the submarket occupancy as at December 2020.
    • Prime US REIT (SGX:OXMU) and Manulife US REIT both have less than 10% of lease expiries in FY21 of 8.8% and 4.4% respectively. PRIME has the lowest total lease expiries in FY21 and FY22 of 16.9% vs Manulife US REIT and Keppel Pacific Oak US REIT at above 20%.
    • Both Prime US REIT and Manulife US REIT have indicated their interests in making potential accretive acquisitions of assets that have a higher tenant profile of expanding sectors. These include the technology sector that is expected to enjoy long-term structural growth moving forward.
    • Based on JLL’s outlook/commentary, key submarkets that are expected to see a recovery contributes approximately 37% and 33% of Prime US REIT’s and Manulife US REIT’s NPI respectively. However, we note that there are positive catalysts/green shoots seen in the Seattle market in 2H21 which contributes ~45% of Keppel Pacific Oak US REIT’s NPI.


More in the report attached below.






Rachel TAN DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2021-03-12
SGX Stock Analyst Report BUY MAINTAIN BUY 1.000 SAME 1.000
BUY MAINTAIN BUY 0.850 SAME 0.850
BUY MAINTAIN BUY 0.900 SAME 0.900



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