• Maintain BUY, new TP of USD0.43 from USD0.64, 45% upside with c.16% FY23F yield. Manulife US REIT’s sharp valuation decline indicates that the US office market remains in a state of flux, and that our earlier view of a potential recovery in 2H22 was misplaced. The REIT is undergoing a strategic review, and a positive outcome – in our view – would be its sponsor lending support by acquiring or taking stakes in its assets or via equity funding. It is trading at distressed valuations, ie at a >40% discount to marked-down book value.

• Worse-than-expected asset value decline of c.11%... This was driven mainly by Figueroa, Los Angeles which saw a 33% drop in value, accounting for 48% of total value decline. This was mainly due to: i) The imminent exit of the anchor tenant, TCW Group by end-2023, ii) downsizing of another Quinn Emanuel, and iii) the cap rate rising by 100bps. On a blended basis, discount rates and terminal cap rate assumption by valuers are c.40-50bps higher. This was on the back of a sharp spike in rates, office transactions coming to a near-standstill in 2H22 due to the lack of interest, and banks pulling back on financing. Other assets which saw a double-digit percentage valuation decline include Plaza, Exchange in New Jersey, Penn and Centerpointe in Virginia highlighting the greater impact in gateway cities while secondary markets fared relatively better.

• ...bringing its gearing to the edge of c.49%, the highest currently among S-REITs and closer to the maximum allowed threshold limit of 50%. Its interest cover ratio (ICR) as at end-Dec 20222 was estimated at 3.1x. S- REITs are allowed a maximum gearing of up to 50%, provided the ICR is above 2.5x and up to 45% if the ICR is below 2.5x. As interest rates have spiked up sharply since 2H22, we think the ICR could drop below 2.5x by end-2023 – indicating that remedial measures are needed soon.

• Will Manulife lend support? MUST is currently in a strategic review to cut its gearing and unlock value. While the REIT has been on the active lookout for divestment opportunities, the current adverse market conditions has limited such options. Its sponsor, Manulife (link), currently manages global real estate worth of USD20.3bn (as of 1H23) and holds a c.9% stake in the REIT. We believe possible options for the sponsor are: Set up a real estate fund to buy some of MUST’s assets, or take a stake in the assets based on their latest valuations. It could also underwrite equity fund-raising at a premium, although the maximum 10% stake cap limits such options.

• We cut FY23-24F DPU by 15% by trimming the dividend payout ratio to 90% (vs 100%) as we expect MUST to conserve cash, and also by adjusting occupancy rate and financing assumptions. We raise our COE estimate by 170bps and lower the terminal growth assumption to 1.5% (from 2.0%), resulting in a lower TP. MUST has a top ESG score of 3.3 out of 4.0, and, as such, we apply a 6% ESG premium to intrinsic value to derive our TP.

Source: RHB Research - 3 Jan 2023