Saturday 26 August 2023

US Office REITs: High Dividends, Low Price Book, WIth High Risk

While focus has been on China's real estate debt; across the Pacific Ocean, USA is facing a real estate debt crisis in its commercial space due to an oversupply of office, this has caused the Singapore listed US REITs of Manulife, Prime and KeppelPacificoak (KeppacOak) to bet trading at insanely low valuation of 19% yield. Yes, putting in $1 million (except Manulife) will nett you a $190,000 annual dividends. 

US Commercial Space- Falling Occupancy Rate

Post pandemic, CNN has reported only 49.7% of US office workers have returned to work. Companies in US are realising that they do not need that much office space and plan to downsize over the next 3 years. Office vacancy rates are currently at 22.4% in New York and 31.8% in San Francisco while overall vacancy rate in the country stands at 12%. Over the next 3 years, the vacancy rates are expected to go higher.

These 3 REITs have seen a fall in their properties' occupancy. Below is snapshot of a few of their metrics:

Given the prolonged crisis, one can reasonably expect further declines in occupancy rate until end 2024. Both PRIME and Manulife runs the risk of seeing their occupancy drop to 80%. This will mean a downward pressure on the valuation of their properties year end. Due to a decline in asset value, their leverage ratios will increase.

It is reasonable to expect a decline of 10% in property valuation given the fall in occupancy rates coupled with higher risk free rates. This will put PRIME at 48%. Keppac at 42.5% while Manulife will be mired in a higher risk of breaching its US$1 billion loan conditions and need refinancing.

US Debt Defaults

A Brookfield fund has defaulted on over US$1bn in debt on properties in Downtown Los Angeles, and is at risk of default on another US$763m coming due in October, while Pimco's Columbia Property Trust has defaulted on US$1.7bn in debt. Closer to home,  Manulife REIT is another candidate.

When it comes to default, the name of Wework cannot be ignored as it lurches closer to bankruptcy on the back of a billion dollar debt. It faced the same problem- a declining occupancy rate among its US offices with tenants no longer subleasing, falling property valuations that has impeded its debt financing.

For Us, Singapore Investors

The US Office REIT no doubt has a mouth watering dividend yield. However, the crisis in USA is the explanation for it. A lot hinges on how well the REIT managers can manage its leverage ratio and prevent it from breaching conditions and defaulting. 

Despite the attractive High dividend/ Low price book ratio, I am neutral on the sector with a slight upwards bias towards Keppel. The manager has shown that it has good execution and its properties are not in the major cities such as New York and Silicon Valley but in sun belt cities which are less impacted by the US real estate crisis. I am of the view while Keppel may reduce its dividends slightly, equity raising is unlikely to happen for it due to its low leverage ratio.

On the other hand, Manulife is definitely a REIT I will not bottom fish. The REIT is currently rather far from its debt covenant ratios and with its market cap, a rights issue will badly dilute existing minority shareholders. The alternative and more plausible outcome is that Manulife REIT will be taken private by the parent (Manulife) between 0.2-0.3 price book value or have most of its properties sold to them. This suggests a small upside of only 20% but with a need to own its shares for a long time as the debt saga continues to draw out and the parent Manulife decides on the best course of action.

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