On Feb 15, Keppel Pacific Oak US REIT’s (KORE) manager announced it plans to suspend distributions along with a recapitalisation plan. KORE was scheduled to announce its results for the FY2023 ended Dec 31, 2023, on Jan 30 but re-scheduled to Feb 15. Its unit price plunged this morning by more than 39% to as low as 15.2 US cents in reaction. Units in KORE closed at 25 US cents on Feb 14.
Although KORE announced an aggregate leverage of 43.2% following its FY2023 valuation, its bank covenants limit the REIT to a loan-to-value of 50%. “Lenders remain concerned about the US office market,” the REIT’s manager says. “Banks are reluctant to lend above 45% leverage for the US market.”
In addition, the regulatory aggregate leverage limits KORE to 50% if its interest coverage ratio (ICR) remains at 2.5 times or higher.
The manager says it is taking proactive measures, with the goal of keeping leverage and interest coverage ratio well within the Monetary Authority of Singapore's (MAS) requirements and banks’ expectations.
KORE is unable to divest any properties at this point at a price that would be beneficial to KORE and its unitholders. Any divestment at this point would probably be at a discount to valuation because there is a disconnect between valuations by valuers and market prices.
Based on discussions with various banks, an equity fundraising (EFR) is unlikely to raise enough equity capital in the present market environment to solve leverage concerns on a long-term basis and would likely require KORE to seek additional capital from unitholders again in the near future.
As such, the manager determined the best option for KORE and its unitholders is to suspend distributions beginning 2HFY2023.
KORE expects distributions will be suspended through the 2HFY2025 distribution that would otherwise be paid in 1HFY2026. This option is expected to provide significantly more capital over two years compared to what an EFR could raise today. If market conditions allow, distributions may re-commence at an earlier date than planned.
In the US, landlords are responsible for funding tenants' improvements in addition to funding new or improved tenant amenities, leasing commissions and other costs. This is very different from the Singapore office market and therefore office REITs that invest in the US require more capital investment than office REITs that invest in Singapore.
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Without the necessary capital investments, US landlords’ ability to retain tenants and attract new ones would be greatly compromised, thus leading to a decline in occupancies and NPI, resulting in valuations declining even more significantly.
By suspending distributions and investing capital wisely, KORE’s goal is to maintain its leverage within the MAS limits and bank debt covenants. However, there is always the risk that asset valuations could change enough to cause KORE to exceed MAS limits or breach the bank debt covenants.
KORE does not anticipate selling any buildings at significant discounts to their current valuation in its recapitalisation plan. KORE will also attempt to refinance the loans that are due in 2024 and 2025 prior to maturity. KORE will continue to invest in the portfolio, with the goal of maximising net property income (NPI) by the end of 2025 and restarting distributions for FY2026.
For the 2HFY2023, KORE reported gross revenue of US$74.8 million ($100.8 million), 1.3% higher y-o-y, mainly from the higher one-off income of US$1.3 million, higher recoverable property expenses and higher car park income as employees return to the office as well as the use of the car park by construction workers from neighbouring developments at The Plaza. This was partly offset by the loss in revenue from the divestments of Northridge Center and Powers Ferry on July 28, 2022, and Dec 22, 2022, respectively.
Net property income (NPI) increased by 2.3% y-o-y to US$42.2 million with property expenses being relatively flat for the period.
Income available for distribution fell by 10.1% y-o-y to US$26.1 million due to higher financing costs and the divestment of KORE's Atlanta assets in the 2HFY2022 and partly offset by the better performance from KORE's existing portfolio.
Including a fair value loss in derivatives of US$10.3 million in the 2HFY2023, compared to a gain of US$14.4 million in the year before, as well as a 6.8% decrease in portfolio valuations for the FY2023, KORE reported a net loss of US$91.8 million for the 2HFY2023, compared to the net income of US$5.6 million in the corresponding period the year before.
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For FY2023, gross revenue was up by 1.9% y-o-y to US$150.8 million mainly from the higher rental income from the leasing completed in FY2022, as well as built-in-rental escalations for the existing portfolio, higher recoverable property expenses and higher car park income. These were partly offset by the loss in revenue from the divestments of Northridge Center and Powers Ferry.
FY2023's NPI increased by 2.2% y-o-y to US$86.1 million due to the higher revenue although property expenses also rose but by 1.5% y-o-y.
Income available for distribution fell by 13.8% y-o-y to US$52.2 million although the amount distributed to unitholders plunged by 56.9% y-o-y to US$26.1 million due to KORE's plans to suspend distributions from 2HFY2023.
KORE reported a net loss of US$67.7 million for FY2023 compared to the net income of US$48.5 million recorded in FY2022 from higher finance expenses, fair value loss in derivatives and lower portfolio valuation.
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