The manager, sponsor and 12 lenders of Manulife US REIT (MUST) have come up with a formula to save the REIT but will need the cooperation of its independent unitholders.
For unitholders, the choice is between survival and liquidation. To survive, unitholders will have to vote for three ordinary resolutions on Dec 14. Resolution 1 is to approve the sale of Park Place in Arizona to the sponsor for US$98.7 million ($131.47 million). The price is based on the higher of two valuations made in June. Manulife, the REIT’s sponsor, owns 9.8% of MUST.
Resolution 2 is to approve a US$137 million loan from the sponsor to MUST for six years at an interest rate of 7.25%, paid quarterly to the sponsor with an exit premium of up to 21.16%. The total interest payable to the sponsor by MUST works out as US$89.4 million including the exit premium, or about 10% a year.
Resolutions 1 and 2, as interested party transactions (IPT) where the sponsor cannot vote, were evaluated by the independent financial adviser, Deloitte & Touche Corporate Finance. Deloitte has said the two resolutions are “not prejudicial to the interests of MUST and its minority unitholders”.
Resolution 3 is a disposition mandate where the manager, along with the sponsor and the 12 lenders, have agreed will be an initial portfolio of four properties known as tranche 1 assets, to be sold for a minimum of US$328.7 million. The properties are Diablo in Arizona, Figueroa in downtown Los Angeles, Penn in Washington DC and Centerpointe in Fairfax, Virginia. The minimum sale price of US$328.7 million represents no more than a 25% discount to the June 30 valuation of these properties. Distributions were suspended in 2QFY2023 ended June and will remain suspended until the end of 2025.
No matter how unfriendly they appear, these three resolutions will be able to buy time between now and the end of 2025 to tide the REIT over some refinancings. MUST’s loan-to-value (LTV) has risen above the levels stipulated by the Monetary Authority of Singapore — 45% with a minimum interest coverage ratio (ICR) of 2.5 times. The LTV is also likely to rise above the 60% financial covenants with MUST’s 12 banks if there is any further downward revaluation. Since its 2QFY2023 results were announced in August, the REIT had breached its financial covenants’ LTV of 60%. That led to MUST paying down its debt to take its LTV to 56.4% as at June 30.
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Sponsor is ‘last in line’
If approved by unitholders, the recapitalisation exercise will raise US$235.7 million from the sponsor through the sale to the sponsor of Park Place and the sponsor loan of US$137 million. This, coupled with US$50 million of MUST’s cash, will tide the REIT’s refinancing over to late 2025. In fact, the sponsor’s loan is subordinated to the REIT’s bank loans for six years and cannot mature till the other bank loans have been repaid.
The sponsor, manager and 12 lenders of MUST together have an in-principle agreement for the recapitalisation plan although some lenders have yet to formally sign up for the plan. “Various lenders still need to come in with their formal approvals,” says Marc Feliciano, chairman of MUST’s manager and head of Manulife’s global real estate and private markets.
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Following the recapitalisation exercise, including the sale of Park Place and the sponsor-lender loan, LTV is expected to fall to 52.8% while net asset value (NAV) should work out to be 40 US cents. After selling the tranche 1 properties for US$328.7 million, LTV is expected to fall to 49.5% and NAV to 34 US cents.
Undoubtedly, some unitholders may baulk at the cost of the sponsor loan. However, if they want the REIT to survive, they need to vote for all three resolutions as they are interdependent.
The S-REIT sector experienced a failed recapitalisation of Eagle Hospitality Trust LIW . Eagle’s unitholders voted against a recapitalisation plan because they were unhappy with a new fee structure and the high cost of a loan, which led to the liquidation of the trust. While most of the lenders managed to recoup their loans, equity holders received nothing.
Some unitholders may also wonder at the disposition mandate, where — despite recouping a minimum of US$328.7 million — the subsequent agreements on which properties to divest lie with the lenders’ approvals.
Feliciano explains that while the cost of the sponsor loan appears to be high, in terms of comparable pricing for unsecured debt for US office properties, 7.25% is the so-called “current pay rate”.
“To put in a context, there is no financing available in general in the US office property market,” Feliciano points out. “You’re often seeing what we call alternative lenders asking for 18% plus or minus, including some type of equity feature or equity kicker if they can get it. We have to stay behind all the other lenders, we cannot be paid down without all the other lenders approving that. In essence, we’re subordinated from that perspective. We’re last in line,” he adds.
Moreover, Manulife is an insurance company in a heavily regulated sector and is listed in three markets. Hence, unlike one or two Singapore sponsors who had provided their REITs low-cost debt during times of stress, Manulife is unable to do so.
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It was with this in mind that a unitholder, whose average cost is at 17 US cents, says the recapitalisation plan is reasonable. “It looks like there is no choice despite the 10% cost of debt because beggars cannot be choosers,” he says.
Furthermore, the recapitalisation needs to take MUST past its debt expiries as the manager says that it has been unable to access bank debt or any other form of credit following the breach of its financial covenants, the unitholder adds.
Phipps is off the table
To recap, in May, MUST’s manager announced the proposed sale of Phipps, one of MUST’s best properties in the “hot” market of Atlanta, to the sponsor. However, the sale is off the table because the lenders would need to agree to the sale of Phipps.
Phipps’ valuation at the end of June was US$178 million. In an interview back in August, Feliciano had indicated to The Edge Singapore that the sale of Phipps remained on the table but the sponsor and the manager had to have an additional option to refinance MUST’s loans that were due in 2024 and 2025.
As it is, the subsequent agreement with the lenders, the sponsor and the manager is for the properties in what is termed tranche 1, to be divested first, subjected to unitholders’ approval in the EGM.
On Nov 29, the sale of Phipps was taken off the market. Instead, it was classified as tranche 3, a property that MUST is required to retain. In the circular and presentation slides, the sponsor and manager have placed MUST’s portfolio in three buckets, tranches 1, 2 and 3. Tranche 1 properties face risks and challenges in occupancy and require higher capital expenditure (capex) for them to be viable. Some of them are also of an older vintage such as Penn in Washington DC.
Tranche 2 properties face a “medium” occupancy risk and have lower capex needs than tranche 1. These include Plaza in Secaucus, Exchange in Jersey City, Capitol in Sacramento and Peachtree in Atlanta. Tranche 3 are the best properties — Michelson and Phipps.
“When we first met, we described that there has to be a detailed capital market strategy that involves first dealing with the lenders’ existing financing. We have to have a detailed asset strategy, which is how we arrived at tranches 1, 2 and 3. And that leads to a portfolio strategy, in terms of how we optimise across the portfolio based on several factors which include financing,” Feliciano said in a separate interview with The Edge Singapore on Nov 29.
“The lenders, in essence, would not allow the sale of Phipps. If they wanted us to buy Phipps, that’s what they would have pushed. There would be no agreement without the lenders is the way to think about it. All 12 lenders need to formally approve this [recapitalisation] plan for us to get an extension in debt maturities,” Feliciano adds.
“We landed on an asset that was approved by the lenders and not other assets, plus the US$137 million sponsor loan and the US$50 million to get all the lenders’ approval. There is a view that we may be buying one of MUST’s best assets in an IPT,” Feliciano points out. Park Place is what Tripp Gantt, CEO of MUST’s manager, classifies as more a tranche 2 property.
During the analyst and media briefing, Feliciano explained that the sale of Phipps alone would not have been sufficient for the entire refinancing exercise and buy time for the US office market to trough. What the exercise needs to get to is US$285 million to cure the covenant breach.
The plan was “heavily negotiated with 12 lenders, in essence, 12 credit committees and some board approvals”, Feliciano points out in a reply to a question during the briefing. “About 28% of the outstanding balance of US$1.02 billion is being paid down on a pro-rata basis across all loan maturities and all debt maturities are extended one year,” he explains.
Where is the trough?
One way to gauge the trough of the physical US office market is its behaviour during the Global Financial Crisis (GFC). The physical US office market peaked in 2Q2008 and troughed in 2Q2010. The current US office sector peaked in 1Q2022. At the earliest, it could trough in 2H2024 as some economists expect the Federal Reserve to possibly cut the Fed Funds Rate sometime in 2H2024.
DBS Group Research has downgraded MUST to “hold” from “buy”. “With the sponsor-lender loan, we believe that the sponsor will be behind MUST, ensuring it is sustainable until 2025. However, we believe this comes at a hefty price (sponsor loan interest) and the journey to resolving MUST’s debt issue is lengthy with execution risks. We upgraded the stock in early November and highlighted that it was a short-term tactical play on reaching a tripartite agreement with the sponsor, lenders and MUST. However, the long-term resolution could be lengthy with some risks involved. We now take on a more cautious stance in the long term, given the suspension of distributions, uncertainty in the recovery of the US office market and execution risks,” the DBS report says.
All that is left to be said is that MUST’s survival depends on its unitholders voting for all three resolutions as they are interdependent. Otherwise, it will be curtains for the REIT with a fallout affecting US office REITs in Singapore and also the Singapore Exchange S68 ’s most successful asset class.
On the other hand, the recapitalisation buys MUST time up to the end of 2025. “We need to get through the moment, but our expectation is liquidity will pick up,” Feliciano says.
