Manulife US REIT ("MUST") just dropped a bomb shell this morning (30 Dec 2022, 6.48am) on SGX that its fair valuation of investment properties dropped by a whopping <10.9%> (US$237.4Mil) and that its leverage level went up to 49% which is just 1% shy of Monetary Authority of Singapore ("MAS") aggregate leverage limit of 50%. It is fortunate that back in April 2020, MAS had announced that it had raised the leverage limit for S-REITs from 45% to 50%, else MUST would have been in blatant default of regulatory limit already and this may lead to further breaches of financial covenants. Still the current 1% buffer is not at all reassuring. No wonder its unit price has plunged <20%> since 1st December 2022 from US$0.375 to as low as US$0.300 per unit despite no news being announced publicly beforehand- I reckon that some insider news got leaked out way beforehand. What ever lead to this sudden self-implosion that has an ominous and potentially fatal consequence?
1. MUST Own Disaster in the Making?
Note that I am vested in MUST and I was shocked by this announcement as the REIT itself is now hanging by a cliff in terms of its survival. In previous years, MUST had embarked on a path of rapid M&A to build up its properties portfolio and income for distribution. Personally, I do not like the numerous occasions that MUST proceed to issue rights in private placement tranche at a discounted price without making such rights available to existing unit-holders by pointing to the need for urgent completion of the M&A deal. Another consequence of the rapid and aggressive pursuance of M&A deals resulted in its aggregate leverage level becoming one of the highest among US Office REITs at over 40%, thus leaving it with little leeway in the event of major economic downturn which can lead to a drastic fall in the fair valuation of its investment properties.
2. Potential Red Flag of the US Office REIT Managers
I thought that Choon Yuan who runs the Investmoolah blog summed it up beautifully in his posting on US REITs (Why buying US Reits like PRIME and ManuLife Could Be Dangerous) on 29th December 2022, just one day before the disastrous announcement by MUST, on this:
"One thing that worries me is how both managements are not doing a share buyback when they are valued at a 50% discount to their property valuations. The REITs are afterall a portfoilo of properties and at such a discount, REIT managers would have deemed it attractive to be a good buy.
The lack of action by the management shows that either the REITs are short on cash or that they are anticipating a large writedown in property value of a magnitude greater than 20%. These would be terrible situations that the managers are not revealing. For context, a smilar US REIT called Digital Core is buying back its shares during this sell down at the 0.6-0.7 Price book value. Hence, it is no surprise this particular REIT has outperformed the other 2."
3. Why Did the Fair Value of MUST Properties Plunged So Drastically?
The bulk of the decline in fair valuation actually come from Figueroa which dropped US$104Mil (or -33% from prior year). The reason cited by MUST is that in the case of Figueroa, , the valuation as at year end 2022 is reflective of the occupancy plans of the property’s two largest tenants, Quinn Emmanuel and TCW Group, with the former executing a renewal and downsize while the latter plans to vacate at the end of their lease term (31 December 2023). Figueroa makes up 44% of the portfolio valuation decline as at year end 2022.
Personally, I thought that the valuer may have been too conservative in their projection on the replacement of vacated space after the exit of major tenants of Figueroa in 2023.
Parting thoughts
While I was initially optimistic on the future prospect of MUST given that their management is rather pro-active and has commenced its strategic review in early December 2022, the current development is extremely worrying. MUST is coming close to a breach of statutory requirement as well as breaches of banking covenants. We thus cannot rule out a fire sales of its properties or a dilutive rights issuance coming up for MUST. I thought that there is some similarities to the 2008 and 2009 Global Financial Crisis in terms of plunging property valuation of REITs and possible credit squeeze if the US economy continues to spiral downwards.
Choon Yuan (Investmoolah) put up another insightful thoughts of his regarding the current predicament faced by US REITs of risks arising from (i) higher discount rates and capitalisation rates of properties as well as (ii) high vacancy rates. Before ending this post, I will just put up some food for thoughts-I have extracted and placed here his exact words in the comments section of his post during our interaction at his blog:
"The first risk mentioned will affect all US reits from Digicore, Utdhampshire, PRIME, Keppelpac, Manulife; while the second risk has varying degree, I expect all 5 REITs leverage ratio to increase in 2023 and it depends on who will bust the 50% limit first".
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