• Manulife US REIT (SGX:BTOU)'s 3Q22 operational updates show that key gateway office assets are slowly stabilising, with a bottom likely by year’s end. Management expects occupancy to stabilise at current levels, with rent reversions to stay positive.
• While there are challenges in gateway cities offices – on the back of transition to a hybrid working model – it has been priced in, with Manulife US REIT's share price trading at a distressed valuation of 0.5x P/BV and ~15% yields.

Manulife US REIT's 3Q22 Portfolio Occupancy Stood at 88.1%

• Diablo, one of its recently acquired assets, saw the signing of a 10-year lease with a semiconductor firm (+7.3% rent reversion), which took occupancy to 91.1% from 85.7%.
• Physical occupancy at Manulife US REIT's buildings is estimated at low 30% levels (July: 28%) of employees back in its buildings.
• The overall pace of rent reversions improved to +4.3% (1H: +1%), showing tenants’ willingness to pay higher for good quality office spaces. There has been an increasing flight to quality (FTQ) trend, with tenants moving to newer buildings with greater amenities to woo employees back. We also expect recessionary concerns to bring back more employees to offices and improve the leasing momentum.

“Hotelisation” to Capture Flight to Quality (FTQ) Trends

• To capture the FTQ trend, Manulife US REIT plans to continue embarking on asset enhancements by hotelisation, i.e. adding flex and conference/event spaces, and concierge services and food amenities in addition to traditional office space.
• Peachtree will embark on this concept in 1H23 at an estimated capex of US$18m with an expected IRR of ~9% based on rents, which are ~30% higher for such spaces. This follows the introduction of the similar Flex by JLL at 500 Plaza Drive, with the possibility of Michelson seeing an alike upgrade.

Divestment on the Cards to Address Gearing and Interest Cover (ICR) Concerns

• Manulife US REIT's gearing is on the high side at 42.5% and likely to further rise by year’s end with a probable cap rate expansion. ICR currently stands at 3.4x (above the 2.5x requirement for 45% gearing), but is likely to trend lower with rising interest costs.
• It has US$105m (~10%) of loans maturing in 2023, for which Manulife US REIT is in talks, with interest cost for this tranche likely at 100-150bps higher than the current 3.34% pa all-in interest cost.
• ~81% of its loans are currently fixed, with every 100bps rise in interest rate impacting Manulife US REIT's DPU by -2%.

Manulife US REIT - Valuation & Recommendation

• We lower FY23F-24F DPU forecast for Manulife US REIT by 4-5%, mainly to factor in higher-than-expected financing costs. We also raise our COE assumptions by 125bps to factor in higher interest rates and market risks.
• Manulife US REIT has a top ESG score of 3.3 out of 4.0 (based on our proprietary in-house methodology). As this score is 3 notches above country median, we apply a 6% premium.
• Keep BUY rating on Manulife US REIT with new US$0.64 target price from US$0.78, 79% upside from the current Manulife US REIT's share price with ~15% yield.

Source: RHB Invest Research - 2 Nov 2022