Manulife US REIT - UOB Kay Hian 2022-11-03: Challenging Outlook In 3Q22; Hotelisation Of Another Asset

Manulife US REIT - Challenging Outlook In 3Q22; Hotelisation Of Another Asset

  • For 3Q22, Manulife US REIT’s overall portfolio occupancy dipped slightly to 88.1% while physical occupancy remained at around 30%. Some 61,000sf of leases were executed at 4.3% positive rental reversion, leading to a year-to-date positive rental reversion of 1.7%.
  • Net gearing levels remain stable but are likely to inch higher as interest rates rise.
  • Manulife US REIT continues to ramp up its hotelisation efforts, with its Peachtree asset the next asset in line.

Manulife US REIT's 3Q22 update.

Lower overall portfolio occupancy.

  • Overall portfolio occupancy in 3Q22 fell to 88.1% (2Q22: 90.0%), largely due to Quinn Emanuel, a top 10 client by gross rental income, downsizing its office space in Manulife US REIT’s Figueroa asset. However, Manulife US REIT’s Diablo asset increased its occupancy from 85.7% to 91.1% as it signed a 10-year lease with a semi-conductor company, with rents at 7.3% above passing rent.
  • Management expects overall portfolio occupancy to stabilise moving forward. Manulife US REIT has been in negotiation with prospective tenants to take over vacated spaces which we reckon may take some time to backfill. Also, physical occupancy remains at around 30%, similar to 2Q22.

Weak leasing activity.

  • Manulife US REIT executed 61,000sf of leases in 3Q22 (~1.1% of NLA) with +4.3% rental reversion, with 254,000sf of leases executed for 9M22 and year-to-date rental reversion of +1.7%. The positive rental reversion was led by the two leases executed at Peachtree, at double-digit positive rental reversions. Management has maintained its guidance of low-mid single-digit positive rental reversion for its overall portfolio.
  • Manulife US REIT's weighted average lease expiry (WALE) remained steady at 4.9 years (5.0 years in 2Q22) with only 1.3% of leases by net lettable area (NLA) expiring in 2022 (4.8% in 2Q22).

Gearing remains steady.

  • Net gearing levels remained largely stable at 42.5% as of end- 3Q22 (42.4% in 2Q22). However, in the current rising interest rates environment, we expect net gearing to inch up moving forward. With debt headroom of about US$180m (50% gearing level) and interest coverage of 3.4x, we reckon that Manulife US REIT is not at risk of breaking any loan covenants.
  • Manulife US REIT’s fixed rate loans have decreased to 81.1%, down from 85.7% in 2Q22, while its weighted average interest rate increased to 3.34% (2.97% in 2Q22). Every 1% increase in interest rate will impact DPU by 0.105 Ucents (~2% DPU impact), up from 0.079 Ucents in 2Q22.

Ramping up hotelisation efforts.

  • Manulife US REIT partnered with Flex by JLL to take up 15,407sf (3.3% of NLA) of office space in Plaza with an additional 20,451sf (4.4% of NLA) in subsequent phases by 2023, providing enterprise-grade flexible space solutions at an expected stabilised rent premium of 30% to market. The first phase is already underway and is expected to be operational by 2Q23, with phase 2 and 3 operational by 2H23 and 1H24 respectively and at a total cost of US$6.8m. As of end-3Q22, Plaza’s occupancy was 91.1%, and is expected to increase to around 95% once phase 3 is completed.
  • Additionally, Peachtree is next in line for hotelisation in 1H23, at a total cost of US$18m over two years, and is also expected to command rents that are 30% higher upon completion. This is in line with Manulife US REIT’s strategy to ensure its properties remain competitive and command premium rents. Management has noted that they are potentially looking at other assets to undergo hotelisation, with Michelson the next likely target, in our view.

Cautious economic outlook.

  • Despite a challenging global macroeconomic outlook, the US’ GDP rose 2.6% in 3Q22, after two straight quarters of decline. Job employment remains robust and at record lows, while inflation remains persistently high, increasing the likelihood of further interest rate hikes. This has spilled over into the US office sector as according to Jones Lang LaSalle, leasing volumes continue to be sluggish while subleasing has risen in 3Q22 as firms reassess space needs/downsize.
  • US base rents have gradually improved but are dragged down by elevated tenant incentives.

Manulife US REIT – Earnings forecast revision & recommendation

  • With the Fed raising interest rates at an unprecedented rate, we have increased our risk-free rate assumptions and decreased our 2023-24 DPU forecasts by 2-3%, causing our target price to drop from US$0.74 to US$0.63. See previous report: Singapore REITs - UOB Kay Hian 2022-10-14: Rich Pickings Among Bombed-Out US REITs. We think that recent selling has been overdone and most of the negatives have been priced in.
  • Catalysts: Better-than-expected rental reversion. Return to offices in the US.
  • Key risks: Slowdown in the US economy, affecting demand for office space. Further increases in interest rates.

Llelleythan TAN UOB Kay Hian Research | Jonathan KOH CFA UOB Kay Hian | 2022-11-03

Previous report by UOB:
2022-08-08 Manulife US REIT - 1H22 Slight Miss; Facing Challenging Outlook.

Price targets by 5 other brokers at Manulife US REIT Target Prices.
Listing of research reports at Manulife US REIT Analyst Reports.

Relevant links:
Manulife US REIT Share Price History,
Manulife US REIT Announcements,
Manulife US REIT Dividends & Corporate Actions,
Manulife US REIT News Articles

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