• Manulife US REIT's acquisition of 400 Capitol a yield-accretive deal.
• Upside to initial yield of 7.2% as underlying in-place rents are 11% below market asking levels.
• Fund-raising to finance acquisition to boost market cap by US$140m.
• Index inclusion the next catalyst for Manulife US REIT.

Poised to Move Higher

• We maintain our BUY call on MANULIFE US REIT (SGX:BTOU) and our Target Price of US$1.10.
• With the recent acquisition of 400 Capitol, Manulife US REIT continue to offer investors an interesting mix of high yield and growth. With tax concerns largely allayed in our view, we believe that investors will look towards a consistent delivery of a 2.0% DPU CAGR over FY19-21F. See Manulife US REIT's dividend history.
• Potential indexation remains a catalyst. BUY!

Where We Differ: Acquisitions Delivered

• Manulife US REIT delivered two acquisitions in 2019, ahead of investors’ expectations (in line with ours) as it continues to look to grow inorganically, providing investors with improved diversity in earnings, exposure and a stronger growth profile.
• The latest acquisition of 400 Capitol, while accretive, presents upside to cash flows its rents are up to 11.5% below asking levels. We project the property to mark-to-market in the coming years as leases are rolled over. See Manulife US REIT's announcements.

On the Rise

Manulife US REIT (MUST) announced the proposed acquisition of 400 Capitol located in Sacramento, California

• The property is a 29-storey top Class A office building, located in Sacramento’s CBD with an NLA of 500,662 sqft.
• The property offers 1,094 parking spaces, supporting tenants’ needs.
• While the property is over 27 years old (completed in 1992), it has undergone capital upgrades of > US$12m since 2016 with minimal further refurbishment needs going forward.
• Purchase price of US$198.8m (US$397.0 psf is noted to be below replacement cost of US$700 psf) is slightly below valuation of US$200.5m.
• Implied cap of 7.2% is above MUST trading yield.

Steady portfolio metrics with rental upside

• The property has an occupancy rate of 94.9% and is leased to a diversified tenant base of 44 tenants in finance, law, real estate, etc.
• Top 10 tenants account for 65.5% of the property’s gross rental income (GRI), notably WeWork, which contributes 10% of the GRI.
• The property appears to be highly desirable for tenants as it experienced over 80% retention rate over the past three years and with tenants’ forward renewing leases expiring in 2020/2021, improving its weighted average lease expiry (WALE) to 5.9 years.
• The in-place rent of US$39.3 psf/year is 11.5% below the potential asking rents of US$43.8 psf (according to Cushman & Wakefield) and implies the ability to yield up the property in the longer term as the leases are rolled over in the coming years.

Micro-market dynamics support a stronger organic growth profile.

• The property is an iconic Class A Tower with 5-star amenities and an efficient property with LEED platinum design.
• The CBD office supply within Sacramento Downtown/Midtown (the micro-market) is seeing minimal supply completions while historical absorptions have brought vacancy down from > 18% in 2014 to 7% in YTD 2019.
• The micro market has average vacancy of 6.3% vs Class average of 11.3% and with new completions in the next few years, indicate that it remains a favourable market to landlords.

Accretive Deal With Fund-raising; Potential Index Inclusion to be Watched

• In conjunction with the acquisition, Manulife US REIT announced a fund-raising of US$142.1m comprising a placement (priced at US$0.876/unit) to raise gross proceeds of US$80m, after executing on the upsize option and a preferential offering of US$77m (priced at US$0.86), at the higher end of its proposed funding range.
• Based on pro-forma estimates, the deal is expected to be accretive and boost DPUs by 2.3%. However, given that we had previously priced in a US$$200m acquisition; US $140m via fund-raising), our estimates are revised up by < 1.0% given that Manulife US REIT delivers an acquisition with a higher yield (7.2% vs 6.5% estimate).
• Post the increase in capital, Manulife US REIT’s gearing is projected to remain at 36-37%, an optimal level in our view.
• Post fund-raising, Manulife US REIT should meet the criteria to be considered for inclusion in the EPRA NAREIT Developed Asia Index and this could result in potential inclusion in the ext review.

Source: DBS Research - 11 Oct 2019