UOB Kay Hian (UOBKH) is keeping its “overweight” rating on the Singapore REITs (S-REITs) space with a preference for the US REITs listed on Singapore Exchange (SGX).
This came on the back of the US office market eking out a mild 1.4% y-o-y increase in asking rent in 2Q2022 despite a slowdown in leasing volume in 1H2022, according to analysts Jonathan Koh and Llelleythan Tan in their Oct 14 report. Leasing volume slowed for the second consecutive quarter and declined 9% q-o-q to 49 million sq ft in 2Q2022 (84% of pre-pandemic levels).
The REITs' vacancy rate has inched higher by 0.1 percentage point (ppt) q-o-q to 16.9%, a pandemic-era high, with completion of 10 million sq ft outpacing net absorption of 6.2 million sq ft. “Net absorption was only 7.3 million sq ft in 1H2022, a far cry from 19 million sq ft seen in 4Q2021. More tenants are sub-leasing their underutilised office space and sub-lease availability rate has increased 20 basis points (bps) q-o-q to a record high of 3.9% in 2Q2022,” note the analysts.
Meanwhile, according to CBRE, it seems that the office spaces in the suburban areas of US are outperforming the downtown offices. According to CBRE’s data, average suburban asking rent grew 1.3% y-o-y to US$28.33 psf per year in 2Q2022, compared with an increase of 1.1% to US$52.18 psf per year for downtown offices.
The lacklustre performances from the downtown offices were attributed to the increased supply and slow return of office workers. Vacancy rate for downtown offices increased 20 bps q-o-q to 17.0% in 2Q2022, rising above the 16.8% (-10 bps q-o-q) for suburban offices for the first time in 20 years. Vacancy for downtown offices has risen by 6.2 ppt during the Covid-19 pandemic, compared to a smaller 3.6 ppt for suburban offices.
With that, Koh and Tan believe that the high-growth Sun Belt markets – Austin, Atlanta, Dallas/Fort Worth, Nashville, Raleigh, Denver, San Diego and Charlotte – are the most resilient. Technology and life science hubs, such as San Jose, Los Angeles and Boston, are also growing nicely, they opine.
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“Sun Belt markets have benefitted from in-migration over the past few years. Eight out of the top 10 markets in terms of office-using employment growth over the past 12 months are in Sun Belt markets,” says the analysts, who have also noticed that the Sun Belt markets lead in physical occupancy.
The average physical occupancy for the top-10 cities in the US remains low at 47.4% as of October, but Sun Belt markets lead in terms of physical occupancy (Austin: 63.1%, Houston: 58.1% and Dallas: 53.7%).
“Many companies are moving from two days to three days per week in their hybrid work regime. Time spent on commuting is the biggest hurdle to employees returning to the office. Lately, inflation, which leads to higher costs of transportation, food and childcare, has led to a push back from employees who prefer to work remotely,” notes Koh and Tan.
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Target prices drop on top picks
With that, the analysts like Keppel Pacific Oak REIT (KORE), Manulife US REIT (MUST) and United Hampshire REIT (UHU), as they have spotted bargains emerging with US office REITs trading at an average P/NAV of 0.6 times (lower than 0.75x for S-REITs) amid the US REITs suffering the brunt of the recent indiscriminate selling.
The selling or “carnage” as the analysts put it were caused by panic after the Federal Open Market Committee (FOMC) meeting and UK’s mini budget.
This then caused the US office REITs KORE, MUST and Prime US REIT (PRIME) to have also succumbed to indiscriminate selling and corrected 31.2%, 41.8% and 40.1% respectively on a year-to-date (ytd) basis. UHU, on the other hand, corrected by a smaller 23.3% ytd due to its resiliency.
Koh and Tan also have “buy” calls on KORE, MUST and UHU with target prices of 80 US cents, 63 US cents and 68 US cents. UOBKH does not have coverage on PRIME. “KORE, MUST and UHU provide attractive FY2023 distribution yields of 11.2%, 13.1% and 12.0% respectively,” says Koh and Tan.
The analysts like KORE for its exposure to the suburban office space (77% of portfolio valuation) and Sun Belt states (38% of portfolio valuation). “We cut our FY2023 (ending December 2023) DPU forecast by 6.6% after factoring in Fed Funds Rate hitting 4.5% in early 2023 (previous: 3.5%). We have lowered our target price from 99 US cents to 80 US cents based on dividend discount model (DDM),” say the analysts, who have also increased their risk-free rate on the REIT from 3.0% to 4.0%, in line with higher yield for 10-year US government bonds.
On the other hand, the analysts have noted that MUST saw a drop in overall portfolio occupancy in 2Q2022 driven by non-renewals and downsizing in existing properties. Hence, to backfill these vacancies, MUST has been in negotiation with prospective tenants to take over these vacated spaces, which Koh and Tan reckon may take time.
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Nonetheless, they still like MUST for its hotelisation efforts on its assets. “To ensure its properties remain competitive and command premium rents, MUST has initiated several initiatives such as partnering with best-in-class flex operators to reinvest in its existing office spaces,” explains the analysts.
However, the rising interest rates are somewhat of a concern, which led to the analysts increasing their risk-free rate assumptions and decreasing FY2023 (ending December 2023) DPU forecasts, causing the target price to drop to 63 US cents from 74 US cents previously. “The recent selling is overdone and most of the negatives have been priced in,” they note.
As for UHU, the analysts like that the REIT caters to defensive day-to-day necessity spending at strip centres. “Consumers are expected to pull back from discretionary spending but will devote a larger share of their wallets on day-to-day necessities at strip centres in their neighbourhood. Tenants providing essential services, such as supermarkets, grocery stores, farmer’s markets, convenience stores, pharmacies, medical supplies, home improvement stores, bank branches, laundromats and pet stores, accounted for 67.5% of UHU’s base rental income as of June,” according to Koh and Tan, who also note that UHU has maintained a long weighted average lease expiry (WALE) of 8.0 years.
However, UHU too has been affected by the rate hikes, as it has bank loans of US$94.5 million due for refinancing in March 2023, which would likely see its weighted cost of debt increasing to 4.8% from 3.9%, assuming the bank loans are refinanced at an interest rate of 5.7%.
Thus, the analysts have cut FY2023 (ending December 2023) DPU by 7.8% and lowered their target price to 68 US cents from 83 US cents previously.
As at 11.30am, units in KORE, MUST and UHU are trading at 53 US cents, 38 US cents and 49 US cents respectively.
