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Reviewing Manulife US REIT’s 2019 Full Year Result

Yesterday, Manulife US REIT announced its full-year results. This was the first result since their acquisition of Capitol Mall in Sacramento.

The results was not a good one.

Dividend per unit fell 5.9% from 1.53 cents in Q4 2018 to 1.44 in Q4 2019.

Before Jagjit (the previous CFO) left, he told us to focus on the adjusted DPU. Due to the numerous acquisitions, it would be difficult to track what is the dividends based on the enlarged outstanding unit base.

So let me focus on it.

The Adjusted DPU dropped 4.6% from 1.53 cents to 1.46 cents.

Since this was a six-figure position for me, let me provide some updates. This will be a short update since I have written enough about Manulife US REIT.

Michelson’s Lower Occupancy

Management updated in their financial statements that much of the fall in DPU was due to Michelson, their Trophy asset in Orange County.

I ask if the fall in DPU it was due to other attributable reason but management reveal it was mainly due to Michelson.

Last quarter, Michelson’s occupancy was 96% but this quarter it was reported as 90%.

From what we understand there was a vacancy in mid-October. So the vacancy period was about 75 days.

Not just that, the newest acquisition Capitol Mall only contribute for 60 days while the outstanding unit base increased due to the placement and preferential offering.

These factors caused the majority of the fall in DPU.

Management had a tenant ready to sign up. They are one of the biggest co-sharing company in the world. But at that time, the co-sharing company was embroiled in enough controversies.

Management deliberated and decided to cut from this tenant. Too high of an amount of co-sharing tenant would affect an office building’s valuation. In this case, management would rather lease to some longer-term tenants with lesser problems.

They are still leasing it out and are optimistic given the level of enquiries they have gotten.

Strong Leasing Momentum

In the reporting year of 2019, Manulife US REIT renewed 9% of their portfolio leases. The overall rental reversion was 0.5%.

This looks pathetic until you exclude Michelson’s rent reversion. Then it would be a very good 12%.

Michelson’s rental escalation ran past the market rent. As such on average, the lease was renewed on average 12% below the previous passing rent.

Management also reported that year to date in 2020, they managed to renew a further 70,000 sq ft of space in Plaza, Peachtree, and Figueroa.

From what I understood the rent reversion is good for these leases signed up on January 2020. From what I understood, the rent reversion is in a low double-digit.

We Should see Michelson’s Cash Flow Being Restored Next Time.

While Michelson’s rental reversion looks disastrous, in truth, if you have own Michelson 10 years ago, you would not be unhappy your passing rent outrun the market rent. But since we own it for a shorter duration, we have to bear the painful drop in rental revenue.

The cash flow should come back due to the rental escalation.

I tried to ask how long do they expect the cash flow to get back to where it was but no clear guidance was given.

Because within an office building there are many leases, and the leases expire at different time, it is difficult to forecast clearly how long.

Major Mortgage Maturing in 2020

Management updated that in 2020, there is one major mortgage loan that will mature and needs to refinance.

The current interest rate is about 2.45% and likely the interest cost will go up unless interest rate change quite drastically.

Management will be patient to see whether they can get a better interest rate, but if they refinance during this period, their interest rate will be slightly below 3.0%. Not too bad.

FTSE EPRA Nareit Developed Asia Index Incursion the Tailwind They Need

Manulife US REIT share price crossed above $1, rising to a high of $1.05 upon their incursion into the FTSE EPRA Nareit Developed Asia Index.

The incursion into the index would mean that funds who wish to beat or at least keep pace with the index would need to consider the REIT.

From what I understand, they have received attention from regional funds in Thailand, Korea and even in the USA.

The shareholding mix has evolved from more retail and private banking to more institutional.

Future Acquisitions Funding Will Likely Not be too Deeply Discount

Since the shareholding mix is shifting towards more fund and institution centric, it is likely future capital raising will either be placement or preferential offering.

This is because large funds prefer capital raising that is not too dilutive.

This will be better for the minority shareholders as they do not have to be forced to inject more capital in the REIT. As long as the acquisitions improve the DPU, existing shareholders will benefit from an enlarged portfolio.

A Preference for More Resilient Tenants then Technology Tenants

One of the main differences between Keppel Pacific Oak and Manulife US REIT is the former is very much focus on buildings with greater exposure to companies in the technology space.

Manulife US REIT took a different route in preferring tenants who they believe are more resilient. The buildings were carefully chosen such that their key tenants lease their office spaces to be the headquarters.

In more challenging times, tenants tend to consolidate around the headquarters and based on their observations, companies tend to not move away from their headquarters.

Lower Cost of Capital, Greater Interest Points to More Acquisitions in 2020

Manulife US REIT’s current dividend yield is below 6%. In the past at 7%, there are fewer office prospects that would be a value add acquisitions.

At a dividend yield of 5.6%, more office portfolios of greater quality, in more vibrant cities becomes available to be acquired.

Sometimes, you need to know to a certain degree that your capital raising is largely successful for you to confidently purchase a property.

Greater interest from more institutions should ensure that capital raising via placement is less discounted.

Summary

The USD has been quite strong recently and Manulife US REIT can be seen as a proxy to get exposure to the USD.

Manulife US REIT’s 2019 total return was good but for 2 quarters the DPU has dropped.

I tried to explain to the management what investors who do not have access to them see.

There isn’t a lot of metrics that reflect decent, competent management more than DPU growth. I was hoping that last quarter’s 1.48 cents in DPU was just a blip, due mainly to the acquisitions, but this was followed on with an even lower DPU.

Manulife US REIT’s DPU has languished around this range for some time.

As shareholders, I wonder if it is too much to ask if there are some ways to reflect the virtues of an average annual rental escalation of 2.1% a year.

Due to the acquisitions and unit dilutions that comes along with it, investors practically do not see the result of these escalations.

My last DPU projection after the acquisition now looks like a very stupid estimate (annualized 6.28 cents DPU). If they make another acquisition, I am basically going to not do any DPU estimation but just observe if the DPU ever picks up.

I do think that in this low yield environment, there is a high probability Manulife’s dividend yield has more room to be compressed. I suspect Manulife US REIT may have this sweet spot of operating in an environment where there are quite a fair bit of accretive targets.

This might allow the REIT to grow bigger.

Management has also indicated that they are also open to selling their offices if they get an outstanding offers. With a larger portfolio, this may allow them more flexibility to sell one or two properties.

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Elaine keh

Friday 16th of October 2020

Hi Kyith

Thank you so much for sharing your thoughts, learnt a lot from you!

I am just starting to look into US office reits and realised they performed very widely over the last 6 months: Keppel Pacific Oak (CMOU) gained 24.5% Prime US Reit (OXMU) gained 16.7% Manulife US (BTOU) gained 2.7%

Manulife is the largest of the 3, with trophy class assets, yet is the worst performing - sh px has been languishing and is at an attractive 8%.

Could you pls share your thoughts? Many thanks in advance!

Kyith

Saturday 17th of October 2020

I think it depends on what the crowd thinks the price should trade at. Manulife, while having trophy assets, and greater liquidity should trade at a higher valuation. Out of the three, you realize that Manulife's dividend yield is the lowest. This means it is trading at a premium over the rest. Pacific Oak is grade B office but from what I see, it seems getting more and more well supported, so it may be trading at a reasonable yield, relative to Manulife. Prime is more inefficient. what you should be more concerned about, Elaine is what are you looking for. Share price appreciation or total return.

The important thing to consider is also that, these US reit may operate in different parts of the United States. How would the potential change in real estate trend affect them?

Sunny

Monday 10th of February 2020

Kyith,

With Michelson rent being ahead of the market by a large margin, any future rental expiration is likely going to be lower and drag down the portfolio return.

Kyith

Tuesday 11th of February 2020

Majority have been commited. The cash flow will come back up.

Jimmy

Saturday 8th of February 2020

Although I appreciate your insights and efforts in uncovering otherwise unnoticed issues, I hope you can also focus on improving your written grammar. It can be rather painful trying to decipher some of your sentences

Kyith

Saturday 8th of February 2020

Hi Jimmy, thanks for your comments on the grammar. Will try to improve it.

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