SINGAPORE (June 17): DBS Group Research remains positive on the rental outlook for US office REITs, despite growth concerns on the back of ongoing trade tensions.
“Recent discussions with property consultants reaffirmed healthy demand for office space,” says lead analyst Mervin Song in a report on Monday, following site visits to Keppel-KBS US REIT’s (KORE) and Manulife US REIT’s (MUST) properties in the US.
The way Song sees it, the demand for US office space will be supported by either strong individual property characteristics such as location, or active property management via asset enhancement initiatives (AEIs) or usage of spec suites to drive tenant demand.
“During our site tours, a consistent theme was how rising construction costs driven by a tighter labour market restricts new supply growth,” says Song. “Furthermore, with available land being utilised for residential use, [this] results in high replacement costs for office buildings and capital values.”
The healthy demand should translate to higher rents for KORE and MUST, which are seeing in-place rents between 5-20% below market rate. And these expected positive rental reversions will result in higher distribution per unit (DPU) ahead, says Song.
As such, the analyst believes that it is justified for the counters to trade at a premium to book value. He opines that KORE and MUST should trade at 1.15 times to 1.20 times above book value.
DBS is keeping its “buy” calls on KORE and MUST, with target prices at 90 US cents and US$1.00 respectively.
“They are projected to deliver healthy 5-8% 3-year CAGR DPU growth on the back of acquisitions made over the past year, in-built annual rental escalation of 1-3%, and tailwinds from the upturn in rents,” Song says.
At the same time, Song says the share prices of both REITs should benefit from expectations of lower interest rates. DBS economists have projected two rate cuts by the US Federal Reserve in 2019 to mitigate downside risk to economic growth.
“Despite recent growth concerns arising from current trade tensions, we believe KORE’s and MUST’s share prices can perform,” he adds.
Song notes that KORE is positioned in markets with higher than average growth arising from strong population growth and corporate relocations.
Seattle and Austin, which account for close to 61% of the portfolio, have seen rents jump by up to 20% y-o-y in 1Q19.
The analyst adds that this also provides exposure to the growing US tech sector.
At the same time, Song highlights that MUST is a beneficiary of a long WALE of close 6 years and in-place rents that are generally 5-10% below market.
As at 1.14pm, units in KORE are trading 0.7% higher at 75.5 US cents, implying an estimated price-to-earnings (PE) ratio of 15 times and a distribution yield of 8.1% for FY19F.
Meanwhile, units in MUST are trading flat at 87 US cents, implying an estimated PE ratio of 18.5 times and a distribution yield of 7.1% for FY19F.
