Tuesday, 10 May 2022

Manulife US REIT High Distribution Yield of 8.67%- Rosy Future Or Just A Value Trap?

Manulife US REIT ("MUST") just announced its Q1 2022 operational updates. This is one of my major US Office space investments inside my margin portfolio which delivers an effective distribution yield of around 13% per annum along with Keppel Pacific Oak US REIT as well as Prime US REIT with the use of leverage. Things on the surface looks good but the risk of runaway US inflation and US Federal Reserve interest rate hike as well as flexible working hours from home (instead of office) seems to be creating much weakness in its market pricing. MUST seems to have performed the worst out of the other 2 US Office REITs with a drop in market pricing of <18%> since 1st January 2021. From a market price of S$0.743 per unit, the current unit price of MUST at S$0.600 as at 9th May 2022 is only a faint shadow of its former glorious self. I will go on to highlight 3 factors that I am currently not comfortable with regarding MUST.

MUST Q1 2022 operational and financial metrics

1. Occupancy rate has been declining relative to pre-COVID days
While the occupancy rate of 91.7% seems high relative to the "average US Office Class A" rate of 83% ((based on report from JLL US Office Report 1Q 2022), it is nothing short of a disaster if we were to look at the beginning of COVID madness in Q1 2020 where the occupancy rate was 95.8%. If we were to further compare to the pre-COVID days of Q1 2019, the occupancy rate then was even higher at 97.4%. This is an extremely worrying negative trending.

If we delve into the details, MUST have stated 2 points with regard to the headwinds challenge in their business:
(i) Decision makers are unclear on their space requirements due to global uncertainties and employees slow return to office;

(ii) Hybrid working model these days could see incremental 10% of workers working from home up from the pre-COVID levels of 12% (based on Greenstreet report as at 10 Mar 2022).

Personally, I think that the low occupancy rate is one of the main reasons for the sharp decline in MUST market unit price ever since Q1 2021. 

2. Impending interest rate hike and impact
In addition, the cost of borrowings will continue to adversely affect MUST. MUST has a 42% gearing ratio which is relatively higher to the other US Office REITs of approximately 38%.

According to MUST, every 1% increase will impact DPU by 0.075 US Cents. Coupled with the high gearing ratio of 42.8%, MUST maybe in a perfect storm should the drastic approach, employed by the US Federal Reserve, to keep on increasing borrowing rate to tame soaring inflation continues unabated. 

There is an increasing likelihood of a potential crash in investment property valuation should the increase in rates lead to another severe recession akin to the 2008 global financial crisis whereby many REITs were forced to do rights issue at huge discount to maintain the required gearing ratio of 50% mandated by the Monetary Authority of Singapore.

3. Private placements over retail preferential rights issue detrimental to existing unit-holders
While I understand the rationale to do a private placement for the faster speed of obtaining funding and improved trading liquidity (with an enlarged base) to the unit-holders, my personal thought is that such fund raising exercise nevertheless is not opened to existing unit-holders and destroyed much value for loyal unit-holders of MUST. The recent issuance of 154Mil units at US$ 0.649 per unit for the acquisition of Diablo Technology Park, Park Place and Tanasbourne Commerce Center is a very good illustrative example of self-value destruction by MUST.

The as aforesaid mentioned private placement exercise was launched on 30 Nov 2021 at US$0.649 per unit. Before the announcement, MUST was trading at US$0.710 per unit. MUST management has offered a 8.6% discount off the market price for the new unit-holders. Upon completion of the acquisition, MUST market price has plummeted to US$0.66 per unit. I was extremely disappointed with the huge discount offered to the new unit-holders at the expense of existing loyal unit-holders.
Parting Thoughts
US Office REITs are currently facing strong headwinds. In view of the low occupancy rate in US market and impending increase in borrowing costs, I cannot see a rosy road ahead and is waiting for the next quarterly reporting on occupancy rate. Hence in-spite of the seemingly high distribution yield of 8.67% from MUST, there is the big question mark here on whether such payout is sustainable in an increasingly gloomy future.  

Last but not least to balance the viewpoints, analysts at CGS-CIMB have a target price of US$0.86 per unit while analysts at Maybank Securities have a target price of US$0.90 per unit for MUST which is a potential upside of 50%. Personally, I believe in my own eyes for now and has not seen the reversal of the negative declining occupancy rate. I do hope that with the appointment of the new CEO, Mr William David Tripp Gantt on 4th May 2022, he will be able to bring in more yield accretive M&A opportunities for MUST. However, this maybe an extremely arduous task given the current low market pricing which gives a distribution yield of almost 9%. 

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