We hosted MUST management and its sponsor for a post results investor luncheon. Key questions during the meeting were on its organic growth ability, the US office dynamics, robustness of its tax structure, sponsor pipeline and relationship. Management sounded confident on future growth potential with market fundamentals remaining strong. Its recent acquisition demonstrates its ability to deliver inorganic growth via acquisitions from sponsor as well as third party. MUST offers a healthy FY18F yield of 7.1% which is attractive, at >100bps above the office S-REITs average. Maintain BUY with higher TP of USD1.00 (8% upside).

Portfolio rents still 5-15% below market. Manulife US REIT’s (MUST) 1H17 portfolio rent reversions remained strong at +12.7% YoY, underpinned by healthy demand and the prime nature of its office properties. Management noted that average rents across its office properties are still 5-15% below the current passing rents thus, offering room for positive rent growth ahead. Other key drivers for organic growth are the inbuilt rent escalations (c.2.5% pa), occupancy improvements and the AEI contributions.

US office demand supply dynamics remain strong driven by a healthy labour market with an overall unemployment rate at record lows of 4.3% in July 2017. More importantly, unemployment for educated labour, which is the key driver for the prime office demand, remains at just 2.4%. On the supply front, upcoming supply for the micro-markets where its properties are located remains limited. With asking rents still well above its average rents, MUST doesn’t see any near-term weakness.

Tax structure. Many investors expressed concerns on proposed changes to tax regulations and its potential implications on the REIT. Management sees no threats to its tax efficient structure. MUST’s way of deriving income via a ‘US Portfolio Interest Exemption Rule’ is also commonly adopted by many of the global funds.

On the lookout for acquisitions. Despite yield compression and strong liquidity in the market, MUST sees a good potential to grow via acquisitions, with the recent “The Plaza” deal acting as a testimony to its ability. Overall the US office cap rates for tier-1 cities (Class A) properties currently range between 4.5% to 7%, based on CBRE research. Its acquisition targets could be Class A properties in the sub-urban market and Class B in core urban regions.

Strong backing from sponsor ‘Manulife’ who reiterated its full commitment to growing the REIT. Although MUST doesn’t have an explicit ROFR to its portfolio, it expects to derive an advantage from knowledge about properties and its operational track record. Additionally, its sponsors’ strong brand name and financial position should help MUST in closing third party deals.

Maintain BUY, higher TP of USD1.00 (from USD0.99). We tweak our FY18- 19F DPU by 1-2% factoring in lower than expected financing costs and higher rent growth. MUST is a preferred pick in overseas mid-cap REITs for its high yield, organic rent growth and exposure to a rebounding US office market. Key risks: the ability to retain key tenants and changes in underlying tax structure.

Source: RHB Research - 10 Aug 2017