• Keep BUY, with new USD0.25 TP from USD0.40, 48% upside and c.23% yield. Manulife US REIT announced worse-than-expected double-digit portfolio valuation cuts reflecting the harsh US office investment landscape. The steep decline has resulted in a breach of official gearing limits and a slightly breach in loan covenants. MUST is in active discussion with its sponsor and lenders to remedy the situation. Post revaluation, the REIT still trades at c.60% discount to book. Hence, we believe there is some upside potential, even in an orderly liquidation scenario.

• Portfolio valuation declined 15%, which is more than double that of what we anticipated, and this is on top of a 11% decline announced end of last year. 60% of the USD280m decline came from five key gateway city assets in the markets of California, New York, Washington and Atlanta (Figure 2) with valuation declines ranging from 4-27%. Key reasons driving the decline include a change in assumption by valuers with discount rates widening by 50-125bps and terminal cap rates increasing 25-100bps as well as asset specific vacancies, highlighting market uncertainty and higher interest rate outlook. NAV post revaluation is expected to be ~USD0.40.

• In discussion with banks to waive the breach in financial covenants, with the ratio of consolidated total unencumbered debt to consolidated total unencumbered assets at 60.2:100 (marginally above the stipulated 60:100). If the banks do not agree to waive, this will result in MUST not being able to rely on its existing interest rate swaps and lead to higher interest costs. The REIT will also be unlikely to be able to pay its 1H unitholder distributions until the above is resolved. Gearing will rise to c.57% (from 49.5% in 1Q). The breach of gearing and bank covenants will hamper its ability to borrow debt and impact funding capex and tenant incentives.

• High time for sponsor to show more active and immediate support. The Sponsor, Manulife, with its strong financial position could help offer support in the form of i) the completion of the proposed acquisition of The Phipps from the REIT, preferably at an average of year end (Dec 2022) and latest valuation as well as potentially buying back few more assets from the REIT, and ii) working with the lenders in resolving and offering continued financial support to the REIT, and, if needed, provide a shareholder loan or act as a lender of the last resort. The REIT manager also guided that it is considering seeking a disposition mandate from unitholders that would help in providing more flexibility to dispose certain assets as long as the disposition meets certain conditions. This, in our view, is reasonable as the current buyers’ market conditions need a speedy execution process.

• We lower FY24F-25F DPU by 5% and 3%, adjusting occupancy assumptions and raising our COE assumptions by 5ppts amid increased uncertainty. ESG score of 3.2 (out of 4.0) is two notches above the country median score. As such, we apply a 4% ESG premium.

Source: RHB Research - 19 Jul 2023