UOB Kay Hian (UOBKH) analyst Jonathan Koh has maintained his “buy” call on Keppel Pacific Oak US REIT (KORE) as he sees a “gradual and steady recovery” as well as stable occupancy in the REIT’s 3QFY2024 ended Sept 30 update.
That said, he has downgraded the REIT’s target price to 38 US cents (50 cents) from 39 US cents previously.
In his report dated Oct 25, the analyst notes KORE’s 3QFY2024 distributable income of US$11.9 million, while down by 8.8% y-o-y, remained broadly in line with his expectations.
The REIT also reported lower revenue and net property income (NPI) in the quarter. Gross revenue fell by 2% y-o-y to US$37.6 million while NPI fell by 8.8% y-o-y to US$20.1 million.
Excluding non-cash adjustments, such as lease incentives and amortisation of straight-line rent and leasing commissions, adjusted NPI declined 6.6% y-o-y due to higher repair and maintenance costs in 3QFY2024 and the absence of the one-off termination fee in 3QFY2023, the analyst notes.
Meanwhile, KORE’s finance expenses increased by 9.3% y-o-y to US$7.6 million as a result of higher interest rates.
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KORE also reported a negative rental reversion of 1.2% for 721,392 sq ft of office space leased in 9MFY2024, which represents 15% of its portfolio net lettable area (NLA). The REIT incurred negative rental reversion of 3.5% in 3QFY2024, as a result of new leases at The Plaza Buildings in Bellevue, which has lower rents but also lower tenant incentives. However, KORE benefits from a 2.6% built-in average annual rent escalation across its portfolio, Koh points out.
While portfolio occupancy has fallen 2.0 percentage points (ppt) q-o-q to 88.7% in 3QFY2024, it remains above the industry average, the analyst notes. “Occupancy at The Plaza Buildings in Bellevue fell 8.0 ppts q-o-q to 80.5% due to bunching up of lease expiries, which management had cautioned previously.”
“KORE has built one full floor of spec suites at The Plaza Buildings to attract prospective tenants. There are frictional vacancies at Bellevue Technology Center in Bellevue and The Westpark Portfolio in Redmond, which are expected to be backfilled in subsequent quarters,” Koh adds.
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Koh, referring to data from Jones Lang LaSalle, states that leasing activities have recovered. “Growth cities in the Sun Belt, which accounted for 51.6% of KORE’s NPI, outperformed with leasing activities up 9.4% q-o-q and reaching 96% of pre-pandemic levels,” he says. “For KORE, physical occupancy improved [by] 3 ppts q-o-q to 73% in 3QFY2024.”
In 4QFY2024, Koh expects the REIT’s portfolio occupancy to hover sideways at 88% - 89%, and decrease slightly in 1QFY2025 before recovering to 88% - 89% by the end of FY2025. Management also expects KORE’s rental reversion to range from -5% to +5% in FY2025.
KORE is looking to recapitalise its balance sheet by suspending distributions in FY2024 and FY2025 and management intends to resume distribution in 1HFY2026. The REIT’s capital expenditure (capex) is estimated at US$60 million and US$50 million for FY2024 and FY2025, respectively.
Koh notes that “these investments are necessary to retain tenants and attract new ones.”
“Retaining cash to fund capex reduces the risk of KORE breaching regulatory limits on aggregate leverage,” he adds.
Looking ahead, management is exploring divestment of Iron Point in Sacramento and 1800 West Loop South in Houston. However, Koh notes that banks are reluctant to lend to buyers of office buildings.
As such, KORE is expected to stick to its planning schedule to resume distribution in 1H2026 given it is unlikely to be able to deleverage through divestment in 2025.
Koh has lowered his FY2026 distribution per unit (DPU) forecast by 2% due to marginally lower occupancy.
