• BUY, new TP of USD0.77 from USD1, 59% upside. Prime US REIT’s 3Q22 and 9M22 earnings are in line. There were positive read-throughs, with a healthy pick-up in office leasing activity (in 3Q), on par with the total of 1H22. Management also gave more colour on debt hedges and interest rate risk management strategies, which lends us some comfort. The counter has been oversold along with its peers, and trading close to distressed levels (ie below pandemic levels) – at 0.6x P/BV with a c.14% FY22F yield, amid an overly bearish outlook for the US office sub-sector.

• 3Q22 leasing volume picked up to 246k sqf (1H22: 258k sqf, 3Q21: 187ksqf). More importantly, leasing activity was broad-based at eight of its 13 assets. Serviced office player Regus took up two-thirds of the space WeWork vacated at Tower 1 at Emeryville, lifting the occupancy rate by 18ppt to 77%. PRIME is also in active discussions with a tenant to backfill the space vacated by Whitley Bradley & Brown in Reston Square in July. Its portfolio occupancy rate, as a result, remained stable QoQ at 89.6%. Physical occupancy rates (return to office) in its office buildings have been improving and now vary from the mid-20% to high 70% levels, with lower utilisation rates mainly at its California, Washington and Denver assets and from government tenants. JLL data shows that office re-entry levels reached a post-pandemic high in late September, with more companies issuing stricter return-to-office guidelines.

• Office rental rates show little signs of slowing down. Despite the hike in vacancies, there has been little sign of the rental market slowing down, as tenants have been willing to pay more for good-quality premium spaces in order to woo tenants. This was reflected in PRIME registering its 10th straight quarter of positive rental reversions (3Q22: +10.1%), although management noted that tenant incentives have gone up a little. Portfolio average in-place rental rates are still 6.7% below asking rates, and we expect rental reversions to be in the positive mid-single digits in 2023.

• No debt maturity until Jul 2024, with two-thirds of debts hedged until mid-2026 and beyond. PRIME has extendable options under its current loan arrangement, which can be exercised at minimal cost and from longer- tenure interest rate swaps. 83% of its debt is hedged, with every 100bps rate increase expected to decrease DPU by c.2%. Gearing remains comfortable, at 38.7%. We expect a cap rate expansion on the back of rising interest rates, but do not anticipate its portfolio value to decline by >10%.

• We cut FY22-24F DPU by 1%, 4% and 4%, adjusting our occupancy rate and financing cost assumptions. We also lift our COE assumption by 175bps to impute higher interest rates and market risks. PRIME has an ESG score of 3.1 out of 4.0. As this score is one notch above the country median score, we apply a 2% premium to our intrinsic value to derive our TP.

Source: RHB Research - 10 Nov 2022