In the aftermath of the pandemic, one of the hardest hit sectors of the REITs market is the US Office REITs. In comparing the US office REITs, it is basically seeing who has had it worst.
The above is a scene from the movie, I am Legend… I am exaggerating. Just joking. :p
All three US office REITs listed in the Singapore Stock market, have reported declines in FY2022 and 2H2022 DPU. The three REITs are Prime US REIT, Keppel Pacific Oak US REIT (KORE) and Manulife US REIT (MUST). However, MUST showed an improvement in its 2H 2022 gross revenue and net property income.
All three REITs reported revaluation losses, with Keppel Pacific Oak US REIT (KORE) the lowest at just 2.2%, Prime with a 6.7% decline in valuation, and Manulife US REIT (MUST) with a 10.9% decline in valuation.
MUST still have the highest gearing at 48.8% which is a whisker shy of the 50% regulatory limit after the asset valuation decline. It also has the lowest interest coverage ratio at only 3.1x. The interest coverage ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense during a given period.
MUST’s properties also have the highest percentage decline in the 2022 year-end valuation (at -10.9%), and in terms of overall occupancy rate, it is the lowest at 88%. All of MUST’s properties declined in value, with the properties Figueroa (Los Angeles), Plaza (New Jersey), Penn (Washington, D.C.), Exchange (New Jersey), and Centerpointe (Washington, D.C.), accounting for ~80% of the overall portfolio decline.
All of Prime’s properties declined in value but the largest declines in valuation were from Reston Square in suburban Virginia, Village Center Station I, Denver, and One Town Center in Boca Raton Florida.
Most of KORE’s properties declined in value except for 6 (out of 16 properties).
However, in the midst of these bad numbers, surprisingly, Prime’s office rental reversion reached 20.2 percent in Q4 2022 and it marks 11 consecutive quarters of positive rental reversion, with over 99 percent of its office leases having rental escalations. Its office portfolio occupancy held steady at around 89.1 percent during the last quarter of the prior year, while its weighted average lease expiry (WALE) was healthy at 4.1 years.
Prime US REIT’s distribution per unit (DPU) for 2H2022 dropped the most as compared to the DPU in 2H2021, at -12.2%. MUST’s revenue and net property income surprisingly showed improvement at 8.3% and 3.9% respectively.
U.S. Market Outlook
According to MUST, after declining for two consecutive quarters in the first half of 2022, U.S. real GDP finished the second half of the year with annual growth rates of 3.2% and 2.9% in Q3 and Q4 2022, respectively. Despite GDP declines in the first half, the labour market has been resilient, with unemployment ending the year matching pre-pandemic lows of 3.5%. The Federal Reserve, in its effort to combat inflationary pressures, pursued an aggressive monetary stance by raising policy rates 425 basis points over the course of 2022, before tapering to 25 basis points in January 2023. As a result, inflation is showing signs of alleviation. After peaking at a 9.1% annual rate in June 2022, inflation declined to 6.5% annual growth in December 2022. Besides the Fed’s monetary policy, other factors that have contributed to inflation also began to show signs of easing, including supply chain constraints, pandemic restrictions, energy prices and consumer spending.
According to JLL, the U.S. office market experienced a 10.3% decline in leasing activity between 3Q and 4Q 2022. Despite the drop towards the end of the year, leasing volume for 2022 showed a 15.1% YoY gain compared to 2021. The slowdown in activity was most notably felt among large-scale leases; just 42 lease transactions over 100,000 sq ft were signed in the quarter, the lowest since Q4 2021 and more than 50% below the pre-pandemic quarterly average. The U.S. office market continued to experience negative net absorption with -37.4 million sq ft of net absorption in 2022 due to pressures from subleasing and downsizing trends, albeit an improvement compared to -59.0 million sq ft of net absorption in 2021.
The Way Ahead
According to MUST, despite hybrid work and evolving space requirements leading to more tenants rightsizing, MUST continues to see strong demand for new and repositioned offices in attractive locations. It also expects the operating environment to improve for REITs, as the Fed’s tapering of interest rate hikes provides the market with more certainty in 2023.
MUST has kickstarted efforts to improve its financial flexibility with its implementation of a ~91% payout for its 2H 2022 distributable income. MUST continues to explore fundraising options, including asset dispositions, a distribution reinvestment plan and equity injection. It is currently in negotiations with the Sponsor on a potential disposition.
In the case of KORE, it states that its portfolio, which is backed by the resiliency of its key growth markets, is well-positioned to retain tenants. Moving forward, KORE will continue to place its focus and emphasis towards strategic enhancements and will work towards improving leasing momentum and developing appealing amenities to attract quality tenants.
For Prime, it stated that looking ahead, as more tenants implement their return-to-office plans in 2023, Prime is working with the asset and property teams to drive rent growth, to carry out timely amenitisation and enhancements, while maintaining prudence in our capital management strategies to maximize long-term returns to Unitholders.
In Prime’s presentation slide, it stated a report by WFH Research that physical occupancy continues to climb and employees in the US return to the office.
Prime US REIT – current yield is at 18.11%. Value trap or value buy? 4 things you need to know now. (read here)
Thank you for reading.
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