Manulife US REIT 3Q21 Update - Phillip Securities 2021-11-05: Green Shoots In US Office Market


Manulife US REIT 3Q21 Update - Green Shoots In US Office Market

  • No financials provided in this operational update. To recap, Manulife US REIT (SGX:BTOU)'s 1H21 DPU of US$0.027 (- 11.5% y-o-y) was in line, at 47.5% of our FY21e estimate.
  • 9.7% of NLA signed in 9M21 with positive reversions of 1.3%. Higher physical occupancy bodes well for carpark revenue. US office market showing green shoots.
  • Maintain ACCUMULATE rating on Manulife US REIT with DDM-based target price (COE 9.1%) of US$0.84. No change in estimates. Prefer Prime US REIT (SGX:OXMU) in the sector for greater tenant exposure to STEM/TAMI sectors.

The Positives

Improving tenant sentiment.

  • New leases formed 32.3% of leases signed in 3Q21, up from 3.3% for leases signed in 1H21. As of 9M21, 453,000 sq ft or 9.7% of NLA has been signed with positive reversions of 1.3%. Leasing sentiment has improved, evident by the 76% jump in leases signed year-to-October versus FY20 leasing.

Higher physical occupancy should lift carpark income.

  • 3Q21 physical occupancy improved to 60% (1Q21: 11%; 2Q21: 15%). The absence of movement restrictions also benefitted entertainment and fitness venues opposite two of Manulife US REIT’s assets, whose patrons utilise the carparks located in Manulife US REIT’s buildings. Together with the higher physically occupancy at Manulife US REIT’s offices, this points to recovery in carpark income, which contributed ~7% of FY19 revenue.

The Negatives

3Q21 occupancy slid 0.8ppts q-o-q from 91.7% to 90.9%, still above market occupancy of 83.8%.

  • Significant backfilling at Michelson brought occupancy to 87.2%, up from 80.4% in 2Q21. This was offset by a tenant exercising its lease break, returning one floor of space in Manulife US REIT’s Atlanta asset as it adopted a remote work model for its IT department. That said, leases signed post quarter improved occupancy to 91.6%. Leasing remains an immediate priority for Manulife US REIT. There is still some way to go to bring occupancy back to historical levels of ~95%, but the US office sector is showing signs of recovery.

Gearing elevated at 42%, above Manulife US REIT’s targeted gearing of 40%.

  • Gearing crept up largely due to valuation declines since the pandemic. Tenant incentives (TI) offered on new and renewed leases will be financed by debt, which may push gearing higher. However, Manulife US REIT's management believes that the TI requirements are still manageable but hopes to bring gearing down eventually, doing so in conjunction with portfolio reconstitution.


Green shoots for US office market.

  • This can be seen from
    1. improving net effective rents;
    2. lower tenant incentives (TI);
    3. longer lease tenures signed;
    4. decline in subleasing;
    5. 46.4% q-o-q improvement in transactional volume and
    6. improving rental growth outlook for MUST’s cities.
  • Manulife US REIT's net effective rents improved 4.4% and 2.5% since 1Q21 and 2Q21 on the back of declining TIs. TIs declined 5.5% since 1Q21, although free rent period unchanged q-o-q at 8.9 months. Tenants are signing leases for longer tenures, lengthening from 7.1 years as at 1Q21 to 7.7 years as at 3Q21. Subleasing has also declined for the first time since the start of the pandemic. Twelve-month rental forecasts by CoStar Group were less negative for Manulife US REIT’s submarkets, ranging from 0% to +1.1%. This compares to Jul21’s outlook of -2.4% to 0%.

Shifting focus to New Economy sectors and secondary markets

  • According to CBRE, tenants in the tech, healthcare and life science sectors accounted for 31% of leasing demand in 2020. Research by JLL in April 2021 confirmed these sectors are among the top-paying tenant industries. However, these New Economy industries only account for 10% of Manulife US REIT’s tenants, which limits its ability to increase rents.
  • Manulife US REIT’s future acquisitions are likely to focus on secondary markets where these industries are frequently located. Manulife US REIT is eyeing assets with cap rates ranging 6.5% to 7.5% in sunbelt and magnet cities, which includes Seattle, Salt Lake City, Austin, Boston, and Raleigh.
  • Manulife US REIT aims to increase its exposure to New Economy tenants to 20%. It is open to divesting, M&As and JVs to reposition its portfolio. The manager has been actively evaluating deals and has assessed 47 deals year-to-date.

Maintain ACCUMULATE and DDM-based target price of US$0.84

Natalie Ong Phillip Securities Research | https://www.stocksbnb.com/ 2021-11-05