• Stay BUY, revised USD0.74 TP from USD0.87, 37% upside and c.11% yield. Keppel Pacific Oak US REIT posted another strong quarter of operational numbers – defying broader market expectations of a sharp negative impact to the US office sector demand from an evolving hybrid working model. Its portfolio continues to benefit from its choice submarkets (Sun Belt cities) and well-diversified tenant base with limited concentration risks. Rising interest rates impact on financing costs is also well mitigated with no debt maturing until end 2024 and 77% of its debt hedged.

• Adjustable distributable income in 3Q was up 2.1% YoY while actual distributable income fell 8.1% YoY, mainly on management fees fully paid in cash vs 100% in units in 3Q21. In September, KORE refinanced USD180m of loans maturing in Nov 2023 and early 2024 at competitive rates, leaving no further refinancing needs until 4Q24. Overall average interest cost post refinancing (including amortisation of upfront costs) increased marginally by 22bps this quarter to 3.1% while 77% of its debt is hedged, with every 50bps increase in rates resulting in a c.1% DPU impact.

• Portfolio occupancy improved to 92.5% (+0.5ppts QoQ), driven by occupancy improvements at The Plaza buildings (TPB), Bellaire Park (BP), and One Twenty-Five. More importantly, more than half the demand for this quarter came from new and expansion demand, indicating a return of confidence. Physical occupancy at its assets increased to 60% vs c.50%, mirroring the overall market trend of a 49% return to office at the end of September from 30% levels since the start of the year. Rent reversions were also was stronger in 3Q at 5.3% (1H: 1.6%) – management attributed this to lease renewals coming out of its stronger assets, ie TBP and BP. Overall, KORE expects occupancy to be maintained above 90% with positive rent reversions in mid-single digits moving into 2023.

• Cap rate expansions are likely (25-100bps) on rising interest rates but we expect this to vary widely depending on assets and markets. Overall, we do not expect a >5% decline in asset value by end 2022. Gearing is comfortable at 37.5% – it is expected to see a slight reduction from divestment proceeds of Powers Ferry in Atlanta. Acquisitions are less likely in the near term, with focus more on asset enhancements and sustainability increases at its buildings.

• No withholding tax impact. Management again clarified on market speculation that non-US unitholders are not subjected to a 10% withholding tax impact under Section 1446(f), which comes into effect in Jan 2023.

• We have lowered FY23-24F DPU by 3%, factoring in higher interest costs and also raised COE assumptions by 100bps – factoring in higher-than- expected rate hikes. ESG score of 3.0 (out of 4.0) is in line with country median – hence, we apply a 0% premium/discount to our DDM-derived TP.

Source: RHB Research - 27 Oct 2022