Manulife US Real Estate Investment Trust (MUST) is a REIT listed on the Singapore Exchange since 20 May 2016. MUST’s portfolio comprises nine Class A office properties located in California, Georgia, New Jersey, and the Washington D.C. metropolitan area with a combined asset value of US$2.0 billion (as at 31 December 2020).
The COVID-19 pandemic led to a sharp economic decline in the U.S. leading many experts to predict a bleak future for office properties. Similar to many S-REITs, MUST’s unit price declined in 2020 before staging a recovery.
At MUST’s 2021 AGM, CEO Jill Smith took investors through MUST’s FY2020 performance and its developments moving ahead. Here are eight things I learned from the 2021 Manulife US REIT AGM.
1. Despite the pandemic, MUST reported higher net property Income (NPI) and distributable income for FY2020. They increased to US$115.8 million and US$89.0 million respectively during FY2020 with the CEO attributing the increase to contributions from acquisitions made in 2019.
However, distribution per unit (DPU) declined by 5.4% to 5.64 cents. The reasons for the lower DPU were attributed to three main factors: lower rental income due to higher vacancies, lower car park income, and provision for expected credit losses in the second half of 2020.
2. The CEO said that due to the pandemic, prospective tenants halted their search for new spaces while tenants who were due for renewal were slow to act. Occupancy rates declined from 95.8% to 93.4% by the end of FY2020. However, the CEO mentioned that MUST’s occupancy rate of 93.4% for FY2020 was a good result relative to the U.S. market occupancy rate which fell from an average of 88% at the start of 2020 to 84% by the end of 2020. She added that occupancy for MUST’s properties had been well above the U.S. Class A average for the past five years.
Carpark income was one of the areas where MUST’s revenue suffered in 2020. The CEO said that this was not a surprise due to movement restrictions and work-from-home arrangements.
The CEO added that around half of credit provisions was for a retail tenant and the rest were for food and beverage companies. In February 2021, the same retail tenant reached an agreement to settle arrears in full and resumed payments. She added that some F&B tenants have also made payments and that MUST is working to resolve the rest.
3. Due to the impact of the pandemic, MUST took advantage of ultra-low interest rates and refinanced loans that were due. The rate obtained was 1.85% for five years through a Singapore bank, a rate considerably lower than the 2.46% paid on the original loan. She added that MUST will continue to build a line of undrawn facilities of US$135 million to prepare for unforeseen circumstances. MUST has completed its 2021 loan financing and reduced its weighted average interest rates to 3.18%.
This year’s refinancing took the form of a maiden sustainability-linked loan. The CEO explained the merits of a sustainability-linked loan and that it incorporates the potential for interest rate reductions when sustainability targets are achieved.
Gearing as at 31 December 2020 stood at 41.0% — below the regulatory limit of 50% — providing available debt headroom of up to US$375 million. She added that MUST aims to keep its gearing at around 45%. She suggested that another way to reduce the REIT’s gearing level is by funding an accretive acquisition with a maximum of 35% in debt funding and 65% in equity funding.
4. Property valuations for FY2020 declined by 4.9%. The CEO said that this was due to higher vacancies and estimated higher leasing costs, according to independent appraiser CBRE, assuming zero rental growth in the first year of new leases and renewals.
The CEO said that while the U.S. economy and business conditions are improving, the reality on the ground is that tenants are only tentatively returning to their offices, with physical attendance at MUST’s nine properties varying between 5% and 25%.
The CEO said that despite the slow return, virtual office tours have shown meaningful improvement across all locations. She added that prospective tenants and existing tenants are more prepared to negotiate and sign shorter two or three-year leases rather than five to 10-year leases which were the market norm. MUST’s next valuation point is at mid-2021, which will shed light on leasing prospects for 2021 and 2022.
5. The end of Q1 2021 saw positive strong leasing momentum with 270,000 square feet leased, comprising 5.8% of MUST’s portfolio by net lettable area. The proportion of leases expiring in 2021 have now reduced from 5.7% to 4.3%, while 2022 leases expiring reduced from 18.1% to 13.0%. Rental reversions were up 2.1%.
The CEO said that the MUST’s diversified tenant strategy which comprises 16 trade sectors is paying off. Its top 10 tenants mainly consist of headquarters, government, and listed entities. The CEO shared that despite a difficult patch for one of MUST’s children’s wear retailers, the rest of the tenants have stood strong during COVID-19, highlighting Amazon and Quest Diagnostics as companies that have massively outperformed.
However, she said that while the traditional sectors of legal, government, finance, and insurance protected the REIT’s portfolio in 2020, MUST will be changing up a gear and concentrating on attracting tenants from higher-grade sectors to drive returns.
7. The CEO said that office supply in MUST’s current locations remain negligible, adding that that it will take a brave developer in these current times to commit to building new properties. She shared that Phipps Tower in Buckhead, Atlanta, is 100% occupied, with minimal expiries due. She also said that Peachtree in midtown Atlanta which is due for delivery in 2021 is now 100% pre-leased.
On rental rates, the CEO said that MUST portfolio’s passing rent is close to market rents and that the REIT’s rent forecast is aligned with the U.S. projected 12-month rent growth of negative 2.75%. She shared that the current conditions reflect a tenant’s market, and it’s not surprising that U.S. office rent growth projections are negative.
However, she remarked that 12-month rent projections could be volatile and that rentals could surprise on the upside in late-2021 and in 2022 if the U.S. economy progresses at a positive trajectory.
7. A unitholder asked about the implication on MUST’s earnings in view of the Biden administration’s recently proposed tax hike to increase the U.S. corporate tax rate to as high as 28%. The management explained that the proposed tax hike would have no impact on MUST as it has put in place an efficient tax structure where its tax deductibles (mainly shareholder loan interest and building depreciation) are effective in shielding against U.S. tax.
8. A unitholder asked about the relevance and resiliency of the U.S. office sector post-pandemic, especially if the work-from-home (WFH) model becomes a new normal. According to Cushman & Wakefield, since its lowest point in April 2020, the U.S. added 1.9 million office-using jobs through to March 2021 with office employment expected to reach pre-pandemic levels by mid-2022. An additional 2.3 million office-using jobs over the next two years is also forecasted to put the office-using employment level on track.
WFH in the U.S. was already a common practice with over 50.0% of the workforce given the option to WFH even before the pandemic. Currently, the hybrid model where two or three days in a week are spent at the office seems to be the favoured route and this model requires the same amount of office space.
MUST believes that the physical office will continue to play a vital role for corporations to foster culture and maximise productivity, and that the continued growth of office-using employment will drive occupational demand.
The fifth perspective
2020 was a difficult year as MUST was unable to pursue its original growth plan as opportunities for further accretive acquisitions were hindered due to the market being frozen for most of the year. Capital markets were also sluggish with lenders deeply risk averse.
Despite market conditions, recent data from across the U.S. have shown that average lease tenure in Q1 raised above the seven-year level indicating that tenants are being decisive about need for space and willing to take on longer commitments.
Three critical factors carrying the U.S. economy which could potentially uplift the MUST’s performance include:
- The vaccine rollout in the U.S.
- Fed fiscal stimulus such as the US$1.9 trillion relief bill and the proposed infrastructure renewal program of some US$2.3 trillion to speed up U.S. recovery.
- Future hybrid model of the office which is likely to require the same amount of office space.
MUST had also observed high growth in trade sectors such as technology, healthcare and life sciences, and fast-developing knowledge industries that include entertainment streaming, analytical services, online retailing, and cybersecurity — which all came to the fore during the pandemic. They have the potential to outpace the growth of traditional areas such as finance and insurance.
Looking at the REIT’s assets under management (AUM), it is noticeable that MUST has placed emphasis on the high-growth areas mentioned above. Fifty-two percent of MUST’s AUM includes technology, entertainment, and cloud security services.
The underlying quality of MUST’s nine Class A office buildings in the U.S. has enabled the REIT to weather the impact of the pandemic. With the long-term positive expectations for the U.S. economy, and the REIT’s positioning to capitalize on post-pandemic themes for future acquisitions, this could lead to growth in new frontiers to rejuvenate MUST’s prospects moving forward.
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