• Keep BUY, new USD0.64 TP from USD0.78, 79% upside with c.15% yield. 3Q operational updates show that key gateway office assets are slowly stabilising, with a bottom likely by year’s end. Management expects occupancy to stabilise at current levels, with rent reversions to stay positive. While there are challenges in gateway cities offices – on the back of transition to a hybrid working model – it has been priced in, with Manulife US REIT trading at a distressed valuation of 0.5x P/BV and c.15% yields.

• 3Q portfolio occupancy stood at 88.1% (2Q: 90%), largely on the earlier- announced downsizing of MUST’s seventh-largest tenant – Quinn Emmanuel – to 61k sq ft from 135k sq ft. Diablo, one of its recently acquired assets, saw the signing of a 10-year lease with a semiconductor firm (+7.3% rent reversion), which took occupancy to 91.1% from 85.7%. Physical occupancy at its buildings is estimated at low 30% levels (July: 28%) of employees back in its buildings. The overall pace of rent reversions improved to +4.3% (1H: +1%), showing tenants’ willingness to pay higher for good quality office spaces. There has been an increasing flight to quality (FTQ) trend, with tenants moving to newer buildings with greater amenities to woo employees back. We also expect recessionary concerns to bring back more employees to offices and improve the leasing momentum.

• “Hotelisation” to capture FTQ trends. To capture the FTQ trend, MUST plans to continue embarking on asset enhancements by hotelisation, ie adding flex and conference/event spaces, and concierge services and food amenities in addition to traditional office space. Peachtree will embark on this concept in 1H23 at an estimated capex of USD18m with an expected IRR of c.9% based on rents, which are c.30% higher for such spaces. This follows the introduction of the similar Flex by JLL at 500 Plaza Drive, with the possibility of Michelson seeing an alike upgrade.

• Divestment on the cards to address gearing and interest cover (ICR) concerns. Gearing is on the high side at 42.5% and likely to further rise by year’s end with a probable cap rate expansion. ICR currently stands at 3.4x (above the 2.5x requirement for 45% gearing), but is likely to trend lower with rising interest costs. It has USD105m (c.10%) of loans maturing in 2023, for which MUST is in talks, with interest cost for this tranche likely at 100-150bps higher than the current 3.34% pa all-in interest cost. ~81% of its loans are currently fixed, with every 100bps rise impacting DPU by -2%.

• We lower FY23F-24F DPU by 4-5%, mainly to factor in higher-than- expected financing costs. We also raise our COE assumptions by 125bps to factor in higher interest rates and market risks. MUST has a top ESG score of 3.3 out of 4.0 (based on our proprietary in-house methodology). As this score is three notches above country median, we apply a 6% premium.

Source: RHB Research - 3 Nov 2022