SINGAPORE (July 20): PhillipCapital is initiating a “buy” on US office REITs as the sector has remain resilient amid a new normal. The research house has also initiated “buy” calls on its top sector picks Manulife US REIT and Prime US REIT with target prices of 80 US cents and 88 US cents, respectively.
The US economy faced a rough start to 2020, as the year opened with a global pandemic. US GDP shrank 4.8% in the first quarter - the biggest contraction since the financial crisis, and the economy is expected to contract between 3.6% and 7.4% in 2020.
In the near-term, the pandemic has resulted in fewer workers in the office and more satellite offices being built up in the suburbs.
However, in a Monday report, analyst Tan Jie Hui says, “We believe working from home is not a permanent solution that can replace physical office materially.”
This is because the office remains to be the most productive working environment, and the multi-year trend towards densification of office space is expected to pause, providing near-term support for leasing demand.
To that end, the analyst sees that the US office REITs are currently under the spotlight with attractive dividend yields of about 8%. And this is amid the current economic climate where interest rates globally are depressed.
“The yields of SG-listed US office REITs also outperform that of both SG office REITS and US-listed US office REITs by 1.7 times. In terms of its risk-reward, we believe that US office REITs are worth the investment in the long run,” notes Tan.
Meanwhile, Covid-19 has accelerated trends such as remote working and telecommuting, but the US has already embraced this trend before Covid-19 and has employed a substantial percentage of remote-working employees.
This could be a risk as consolidation/downsizing within industries may lead to greater ‘shadow market’ space should current tenants be allowed to sublet their space. Held together, this could point towards a softer leasing environment.
Employers, however, still do see merits in a dynamic working environment. Coupled with long WALEs, the income stream for office REITs is usually predictable for 5-10 years into the future.
Aside from new working tends, the pandemic has also caused many to lose their jobs. The US unemployment rate surged to its peak of 14.7% in April before declining to 11.2% in June.
However, the unemployment rates in June for the anchor industries in the office – Financial Activities and Professional & Business services was 5.1% and 8.6% respectively, which is the lowest few amongst the industries.
“Using 2008 GFC as a recent crisis proxy, business formations in the US grew steadily over 10 years at a CAGR of 4% as the US economy recovered,” says Tan.
With the tech, financial and professional services seeing the lowest unemployment rate, these sectors are the top leasing drivers for office space demand. And the analyst believes that this demand will moderate and not abate.
These long-standing pillars of the economy have a long heritage of refining how they do business. The existence of virtual conferencing tools predates COVID, but the fact that these sectors still choose to conduct certain functions/elements of business in the flesh implies that these sectors are best served by office premise and explains the pre-disposition for the office environment.
“We believe that the structural shifts in the office landscape will be gradual rather than immediate, with the desire for physical collaboration and networking resulting in the maintenance of an office address,” says Tan.
