As part of potentially investing in Manulife US REIT, I am writing a set of posts to determine whether this could be an addition to my stock portfolio.
In the spirit of trying to be objective (though I already have some bias toward buying the stock), I am going to try to approach this investment decision to buy Manulife US REIT with a blank slate.
I will try to let the REIT speak for itself, and at the end of the day determine if it’s worth the addition.
What is Manulife US REIT
Manulife US REIT has assets in 5 places – Figueroa, Michelson, Peachtree, Plaza and Exchange.
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Their 3Q2017 presentation slides does not include Exchange as it was recently acquired.
At 30 Sept 2017, the value of their investment properties stood at US$975m.
I find this a comfortable size as it’s not too small.
Closing price on 9 Jan is US$0.96.
This is a premium compared to 30 Sept 2017’s NAV per unit of US$0.86.
I admit I’m not that familiar with the US market so the spatial attributes will be lost on me.
Weighted Average Lease to Expiry
Nevertheless, the WALE of 5.9 years means there will be certainty of income for the next 5 years.
According to Manulife US REIT’s slides at 3Q2017, 69.3% and 73.1% of the leases by cash rental income and net lettable area will expire in 2022 and beyond.
In 2017 and 2018, less than 3% is due for expiry.
I find Manulife US REIT’s gearing ratio of 33.1% in the comfortable range.
Using 45% of total investment property value of US$975m equating to US$439m, Manulife US REIT has a debt headroom of US$103m. Their current borrowing is US$336m.
Using a more conservative 40% times US$975m equating to US$390m, they have a debt headroom of US$54m.
Assuming a loan-to-value ratio of 50% for future acquisitions, Manulife US REIT would be able to acquire properties of between US$108m (54m x 2) and US$206m (103m x 2).
Their weighted average interest rate of 2.6% p.a. translates into interest expense of US$2.2m in 3Q2017 or about US$8.8m annualized.
With net property income of US$14.4m in 3Q2017, 15% of it goes to servicing the loan. I find this to be a comfortable number.
If interest rates rise to 4%, their interest expense will be US$13.4m per year, or about US$3.4m per quarter.
At US$3.4m, this will be about 23% of their net property income. A little on the higher side but still manageable I think.
Anyway, 100% of their loans are on fixed rates so the sensitivity is just to get a rough gauge on how much of their net property income will go to servicing the loans if interest rates rise.
For their leases, 99.4% of them have rental escalations.
This is broken down in 75% having escalations of about 2.8% per year. Another 24% have periodic or mid-term increases. The definition of periodic or mid-term is not defined by Manulife US REIT.
A remaining 1% do not have rental increases. This number is not material so will not be in consideration.
Manulife US REIT did not define whether the above breakdown is weighted by number of tenants, income or net lettable area.
Assuming it is by number of tenants, then about 76 tenants have escalations of 2.8% per year. Manulife US REIT has 101 tenants according to their 3Q2017 slides. (29 in Figueroa, 15 in Michelson, 25 in Peachtree, 7 in Plaza and 25 in Exchange).
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In terms of income, 2.8% will mean that 3Q2017’s gross revenue of US$23m will rise to US$23.4m (US$23m grown by 2.8% x 75%) in 3Q2018.
This does not assume positive or negative rental reversions, if any.
I think the increase is marginal. After all, 2.8% is not much higher than inflation and can only just compensate me for the inflation hit.
Nevertheless, 75% of the portfolio having fixed increases is good.
Based on Manulife US REIT’s 3Q2017 slides, I am a little uncomfortable with the net absorption figures of the submarkets the properties are in.
According to the manager, here are the net absorptions in the submarkets
- Downtown LA 290,000 sqft (Figueroa)
- Irvine, Orange County – 206,000 sqft (Michelson)
- Midtown Atlanta – 30,000 sqft (Peachtree)
- Meadowlands – 5,000 sqft (Plaza)
- Hudson Waterfront – 219,000 sqft (Exchange)
Four of the submarkets has negative net absorptions for Class A buildings.
Michelson, which has the shortest WALE of 4.6 years (Figueroa: 5.1, Peachtree: 5.7, Plaza: 8.6, Exchange: 5.8) is very at risk considering that Irvine, Orange County has one of the highest negative net absorption figures.
That is compounded by high vacancy of 17.4% (Downtown LA: 14%, Midtown Atlanta: 11.2%, Meadowlands: 19.2% and Hudson Waterfront: 12.9%).
That said, the other assets have long leases, so there aren’t many near term lease expiries in the coming one to two years.
Rents compared to market
The present rents in the assets are
- Figueroa US$39.4
- Michelson US$48.9
- Peachtree US$31.7
- Plaza US$29.9
Compared to gross asking rents by Costar, the Figueroa asset is below market of US$42.3, Michelson is above market of US$34.4 by quite a bit, Peachtree is below market of US$33.7 and Plaza is below market of US$32.8.
I would think it better if Michelson is below market rather than heavily above, and even if so, just slightly above market.
Nevertheless, 3 out of 4 assets having rents below the market could provide some uplift if/when leases are renewed. However, not a lot of leases are up for renewal so I think upllift will be minimal.
On the positive side, majority of leases have a fixed annual escalation.
Comparison to projections
I would take Manulife US REIT’s very positive performance over projections with a pinch of salt because the projections are what they are, projections, rather than actual performance.
It may have been that the investment bankers were slightly more positive in their underwriting to give Manulife US REIT some breathing room at least in the first few years of operation.
Distribution per unit (DPU) trend
Looking at their DPU trend, it has been a bumpy first few quarters.
- 4Q2016: 1.54 US cents
- 1Q2017: 1.65 US cents (+7%)
- 2Q2017: 1.58 US cents (-4%)
- 3Q2017: 1.60 US cents (+1.2%)
DPU has risen, fallen and then risen since 4Q2016.
Assuming the manager has done some smoothing to the accounts such as amortizing what can be amortized and spacing out lumpy expenses, the gyrations is a little concerning.
I think this will be something to look out for over the next few quarters. I think the market generally does not like negative results so the share price may go through some gyrations if this trend continues.
More important is the underlying quality and fundamentals of what drives the cashflow.
With revenue fairly fixed for the next one to two years (fixed rental escalations and long WALE), I hope the management can control expenses as that will determine how much money becomes available for distribution.
Based on Manulife US REIT’s 3Q2017 DPU of 1.6 US Cents (annualized 6.4 US cents), this translates into a dividend yield of 6.7%.
This level of yield is not attractive enough for me for 1) a REIT with overseas properties 2) fairly new REIT on the scene.
Even though US is a developed and modern economy, I will require some compensation for overseas and foreign exchange risk.
I personally would enter the market if prices correct to anything below US$0.91 (7% yield and above).View Fullscreen
Nothing in this post constitutes investment advice.