Monday 8 May 2023

A 24% Dividend SGX-listed REIT? What's Wrong with PRIME US REIT

Its absolutely surprising to see a SGX listed REIT valued at almost a 24% dividend yield. It will take only about 4-5 years to recuperate your capital and to add to that, the REIT's properties are freehold in nature! That means a perpetual 20+% dividend yielder.

Let's see a screenshot of the current financial situation of PRIME US REIT:

It seems the market feels the REIT manager of PRIME is not seemingly doing a good job and the US commercial market it is in, is in a terrible shape. Let's look at a few factors which could explain the current pricing.

Poor US Commercial Real Estate Market and Overleveraged

A simple google search will show that the US office space is hit with double digits vacancy and falling valuations. PRIME and Manulife REIT are reporting downward valuation of their properties; the chief reason is due to the higher risk free rates that their valuers used. Keppel Pac Oak on the other hand has done well enough to fight off the higher cap rates with better management of the properties and obtained an upwards valuation for its properties; a plus point for Keppel and minus points to the Managers of PRIME and Manulife.

PRIME has clarified that in the 2022 valuation exercise, the cap rate used was 6.56% vs 6.09% used in 2021. With the US risk free rate now at 5%-5.25%, my personal view is that a higher cap rate will be used in the region of 7-7.1% for the end 2023 valuation exercise. 

PRIME's leverage ratio went up about 3% to 42.1% leverage ratio, on the back of a 6.7% valuation decline. With another round of negative revaluation expected, it is likely the new leverage ratio will be around the 45% level, which the REIT manager is looking at. There is a possibility of equity dilution for shareholders given how leveraged the REIT is. This could be due to the past management decision to give 100% of its distributions and not saving for a rainy day such as times like this.

Expectation that PRIME REIT Manager will not Perform like Last Year

In 2022, the REIT manager achieved a positive rental reversion of 11.4%, hence enabling an approximate 6+ cents dividends per unit. However, this was achieved on the back of a debt portfoilo of an effective interest rate of 3.4%

With interest rate remaining high, this means the refinanced interest rates is likely to be in the 6% region. This is bad news because it points to a potential 75% increase in interest expenses. It is unlikely for the manager to perform positive rental reversion of up to 50-70% to meet the higher interest expenses.

With the hindsight poor decision of not keeping potential distributions in the pocket for rainy days, the debt burden is now heavier and this could affect future distribution in 2026 when refinancing occurs.

Unless the REIT manager starts to decide to reduce distribution to a 90% level to pay down the loan or consider a way of refinancing with Singapore banks who are granting loans at the 4% level, unitholders can expect a massive cuts in their dividends in 2026. 

Hence the market expectation is that the REIT manager is not capable enough to maintian current dividend rates; unless of course, Singapore banks are tap on to refinance with them at current Singapore rates.

Unlikely Music will Continue, Poor Occupancy of PRIME Properties

Given the above, it seems tough for PRIME to maintain its 24% yield as the REIT manager would have to perform just as good (though i wont say it is impossible to be done); however unless the REIT manager shows positive steps to right the ship on its high leverage position, the market is now hesitant to accord it a good valuation. Current unitholders will have to suffer the bumpy ride ahead when the physical occupancy rate of PRIME's portfoilo is only at 56%

To add to that, the REIT manager is struggling to backfill the vacanices vacated by previous tenants.

There are ways for the REIT manager to maintain its 6+ cents dividend. However, it needs astute decision to be made until 2026 which market feels is difficult for the current REIT manager to accomplish within 2+ years.

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