Following almost three years of declining distribution per unit (DPU), steadily rising gearing and a halving of its unit price since a year ago, Manulife US REIT (Must) is trying something new.
In August, Must announced plans to “hotelise” certain properties in its pure-play US office portfolio — an asset enhancement initiative that management believes will give it a leg-up in a tenant’s market.
Must’s hypothesis is that offices with premium amenities in great locations are most likely to attract top tenants. These top tenants want more flexibility in their space requirements, with fewer dedicated workstations, more versatile spaces and experiential offerings.
One quarter later, those plans are now in action. At the Nov 2 release of its results for 3QFY2022 ended September, Must announced that Peachtree, its Class-A office building in Atlanta, will embark on hotelisation in 1H2023, while its Plaza building in New Jersey introduced a flexible space solution in 3Q2022.
Works at Peachtree, which will cost some US$18 million ($25.3 million) over two years, will include a grand entrance, lobby, conference centre, coffee bar and outdoor terrace. Must expects an internal rate of return of some 9%.
According to Must, hotelised assets, at US$45-US$55 psf, command rents 30% above Peachtree’s current passing rent (US$38 psf). This potential rental uplift, however, is still below the US$60-US$65 psf commanded by new office properties in that submarket.
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The announcement comes as portfolio occupancy slipped further to 88.1% as of Oct 18, extending a decline from 90.0% as at end-June and 91.7% as at end-March.
Must introduced the hotelisation concept at its 2QFY2022 results release using a different property as an example: Michelson. Located within a mile (1.6km) of John Wayne International Airport, Michelson is a 19-storey, trophy-quality office building in Orange County, California.
Must CEO Tripp Gantt, who took over the reins in May, says Michelson could be next in line for a facelift. “Michelson does have a lot of the attributes that we’re looking at in terms of physical aspects. The building has that really interesting rooftop space; Orange County is a pretty vibrant market as well and has that ‘live, work, play’ environment. It is one of the assets that would be under consideration for this in the next step,” says Gantt in a Nov 2 briefing.
Should Must go ahead with its plans for Michelson, chief investment officer Patrick Browne sees some 25% in rental uplift from its current asking rent.
In response to queries by The Edge Singapore, Gantt says Peachtree was chosen for its “great submarket” of midtown Atlanta. “The Peachtree asset is located right in the middle of it and has fantastic strategic advantages… Peachtree is really the one that we wanted to embark on first because we thought it has the best attributes to undertake this.”
Peachtree’s refurbishment will happen alongside negotiations with new and existing tenants. However, it is still “too premature” to discern the anchor tenant’s intention, says Browne. “All I can say is that we’re being very proactive with our existing tenants, and prospective new tenants. Hopefully, we’ll have more news on the anchor tenant, [who is] one of our top 10 tenants; they have a lease expiration in 2025.”
Meanwhile, Must is partnering commercial real estate services company JLL to provide tenants with flexible workspace at Plaza. As at 3QFY2022, Plaza’s occupancy stood at 91.1%. In Phase 1, due for completion by 2Q2023, this will involve some 15,407 sq ft, or 3.3% of the property’s NLA. In Phase 2 (2H2023) and 3 (4Q2023/1H2024), this could expand to some 20,451 sq ft.
With an estimated cost of US$6.8 million, Must says the potential rent premium is 30% above the market’s rate.
Pure-play office REIT no more?
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Notably, Must says it will form a strategic working group of board and management members to explore a “potential business pivot, strategic partnerships, joint ventures and mergers and acquisitions”. The potential strategy overhaul stems from Must’s persistently high gearing — and taming it is a “primary focus”, says Gantt.
As at Sept 30, gearing stands at 42.5%, holding steady from 42.4% in July, and down from a historical high of 42.8% in March.
“We’re taking a look at all of our options at this point. If we continue doing the same things, we’re going to get the same results,” says Gantt. “We need to take a really strong look at everything that we can do to provide the best opportunities for the REIT and the unitholders going forward. This strategic working group is a serious step in that direction.”
Over the long term, Must’s preferred assets are properties “with less capex needs” in “industries with secular tailwinds”. Says Gantt: “When you look at the asset classes that have those attributes, it can gravitate towards things like industrial; multifamily [assets] have low capex relatively. Exploring these options, our sponsor does have these types of assets in their general account and their real estate portfolios. They have experience managing these, and they have relationships with developers and operators of these property types as well.”
Must may harbour hopes of breaking out of the office sector, but Gantt says the REIT will stick to its US mandate for now. “Our structure is optimised for US investments — in terms of our tax structure and how we operate — and the US dollar is so strong right now. We really feel like we’re going to continue focusing, at least in the short term, on the US.”
Divestment is also on the cards for Must to address gearing and interest cover (ICR) concerns. “We’re taking a look at the properties in our portfolio, and really trying to find the ones that we would be able to get the best price on,” says Gantt.
Must’s weighted average interest rate stands at 3.34% and every 1% increase in interest rate will impact DPU by 0.105 US cents, says management.
The REIT had reported DPU of 2.61 US cents for 1HFY2022, down 3.3% y-o-y. This follows DPU of 5.33 US cents for FY2021 — down 5.5% from FY2020 DPU of 5.64 US cents, which, in turn, was a 5.4% drop in DPU from 5.96 US cents in FY2019.
Some 81% of Must’s loans are currently fixed. It has US$105 million, or some 10% of loans, maturing in 2023, with interest cost for this tranche likely at 100bps to 150bps higher than the current 3.34% perannum all-in interest cost, writes RHB Group Research analyst Vijay Natarajan in a Nov 2 note.
Natarajan says Must’s gearing “is on the high side” and is likely to further rise by year-end with a probable cap rate expansion. “ICR currently stands at 3.4x, above the 2.5x requirement for 45% gearing, but is likely to trend lower with rising interest costs,” he says.
For these reasons, Natarajan brought his target price down from 78 US cents to 64 US cents, while maintaining “buy” on the REIT.
Among research houses, only DBS Group Research issued a more aggressive cut, bringing Must’s target price down from 70 US cents to 48 US cents while maintaining “buy” on the REIT. Units in Must closed at 35 US cents on Nov 4.
Must is now trading below the pandemic trough of March 2020. “At this level, downside risks could be limited,” add DBS analysts Rachel Tan and Derek Tan in a Nov 3 note. “Must is now on a better playing field post inclusion in the FTSE EPRA Nareit Developed Asia Index, where it will likely herald a virtuous cycle of greater investor visibility. Following this, we have already seen higher trading liquidity and yield compression for Must. We believe the new leadership will lead Must into recovery and growth.”
Photos: Manulife US REIT
Infographic: Irene Saswito/The Edge Singapore
