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Understand Prime US REIT better in 24 Points

With the latest move to semi-annual reporting, Prime US REIT will not be announced it’s official financial results.

However, as with many REITs, they are providing business development updates.

The results looked good on paper. Distributable income rose 12.9% from IPO projection. Net property income rose by 6.7%. One of the main reasons the results looked better was because it factors in about 40 days contribution from new acquisition at Park Tower.

Management was kind enough to update us in a media brief. Here are some short points that I could gather.

  1. One of the key criteria for Prime US REIT’s acquisitions is to focus on less dense areas, more affordable areas where there can be population growth and employment growth. Park Tower fits the selection.
  2. Prime US REIT do not have much debt refinance obligations to do until 2024. I did not ask what about the debt obligations maturing in 2022 and 2023.
  3. Just yesterday evening, Prime US REIT announced that they have proactively restructured their existing interest rate swaps by entering a new agreement with Bank of America that locks in the lower interest rate on its borrowings through 2026. This lowers their interest rate from 3.3% to 2.8%. CEO Barbara Cambon guided savings in excess of US$1 mil through 2023. I would think that the savings are actually more, not sure why it is only $1 mil. In this climate, I think it gives investors confidence that such improvements can be done and show evidence of the long term banking relationship built up by KBS with the banks.
  4. Part of the reason the actual numbers looked better than IPO projections was that they can find improvement in interest expenses and trust expenses.
  5. The breakdown in the 12.9% variance in distributable income
    1. 3.2% organic growth
    2. 6.6% park tower
    3. 3.1% savings in trust and interest expenses
  6. Despite MAS relaxing the leverage to 50%, their strategic leverage level has all the while been less than 40% leverage.
  7. Management of Prime US REIT have an aim to see if they could stagger the debt maturity more and diversify their lender base.
  8. Kyith: Interest coverage of 5.8 times and unencumbered assets of 84.8% is very healthy buffer levels.
  9. Their debt covenant on their debt is 45% loan to value
  10. Atlanta, Texas, and Georgia have started plans to re-open for work. Utah was not affected at all during this period.
  11. Companies are starting to strongly consider renewing spaces as opposed to moving out of spaces primarily due to the uncertainty of the economy. There is also a cost for them to move as well.
  12. Out of the 6% lease expiry in 2020, a large percentage belongs to Wells Fargo bank. Pre-IPO, Prime did a very large renewal with Wells Fargo and as part of the renewal, they have the right to give back two floors of space. So there might be more spaces to lease out. Out of all the tenants that management feels are more unknown, they managed to re-leased 45% of them. The tenant retention for these unknown tenants would be closer to 88%.
  13. One of the tenants has sub-leased spaces to sub-tenants. They believe that the sub-tenant will lease the space directly from them.
  14. 9% of the portfolio will expire in 2021 and management is actively negotiating with tenants on 50% of those spaces. They feel that going into 2021, they will have a strong year. They were negotiating for new leases but that died down because prospective new tenants could not go and view the properties. COVID-19 has not slowed down the negotiations.
  15. Across the markets, there have been strong absorption except for Philadelphia
  16. Sodexo’s office is their headquarters
  17. Apache has paid their rent and their lease expires in 2024.
  18. All top 25 tenants paid their rent in April except for WeWork who did not pay 100% of their rent. Aside from WeWork, Prime has 3 more co-working spaces owned by Regus, who is a more traditional co-working player with private offices.
  19. Co-Working spaces represent 3.8% of their cash rental income
  20. The WeWork space is in the San Francisco area and a significant portion of the WeWork tenants are enterprise companies. There is an opportunity to establish a direct relationship with these enterprise companies.
  21. They have provided deferral of rent to about 12 retail tenants. These form a very small percentage to Prime’s rental revenue
  22. Social distancing may become a requirement over time. While leasing may soften, these requirements may mean companies still need quite a fair bit of space.
  23. Management believes this is the first test for remote work. Some companies might find a way to make it work while others may find that they still need an office. IBM and Yahoo tried to do the same 10 years ago but eventually reversed that. There are technologies out there that track their employees when they work at home, mainly because productivity is a suspect. California is considering mandating the spaces per square foot per employee. Prime has fielded inquiries from 4 existing tenants (in banking and technology) with an existing very dense seated environment. If the mandate is to have 250 sqft separation between employees and a company that has 20% of their workforce working from home, the company in question will have to double their spaces based on square foot.
  24. Some sub-leasing colors (In United States, tenants cannot easily break leases. They can, however, sublease to sub-tenants. There is a sub-lease market):
    1. Village Center I: About 25,000 sqft of space sub-leased out. When that expires, Chartered Communications is obligated to take that space
    2. Sodexo: About 18,000 sqft of space
    3. Rovi Corp at Crosspoint: About 36,000 sqft of space
    4. 222 Main: About 12,000 sqft of space
    5. All added up to about 2% of the portfolio

I think it was a good update for me. There is a lot of uncertainty about how real estate will be like after this Coronavirus situation. Everyone is guessing what will happen, and someone is bound to get it right and some will get things wrong.

The situation on the ground probably reflects the real situation: Everyone is trying to figure this out. We hear that prospects are enquiring. Even before this episode, there are companies that have rationalized and have sub-leased out spaces. Existing tenants are enquiring about how to increase their spaces.

Update: This morning, I came across this post talking about how Coronavirus may prompt Americans to move out of cities.

I think a lot of these things are abit of hyperbole. If the best jobs are still going to be in cities, then you got to stay near there. However, it might make sense to stay close by. This could be like the situation for both Manulife and Prime in their Sacramento purchase. It is to tap into the proximity to the more expensive San Francisco area.

Anyway here is what the experts think:

Hopefully this update can give you a better idea about this US Office REIT. Prime US REIT has run up in price a bit. Still provides a prevailing dividend yield of 9.4% based on a unit price of $0.74.

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Alan

Sunday 10th of May 2020

Hi, how do you see Prime REIT compared with Manulife US REIT? I see the latter having stronger sponsor and better properties but I also see the former performing better than the latter. Was wondering whether you see the reasons for that. Thanks bro.

Kyith

Tuesday 12th of May 2020

Hi Alan, the former is less liquid as a share compared to the latter. So I am not sure if it will always perform better. I felt that the value is in Prime, but the share price can drop like a rock. Manulife is a more known commodity.

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