On July 12, 2023, REITsavvy is delighted to have received an invitation from Manulife US REIT (“MUST”) [SGX:BTOU] to attend an exclusive media-only session, where we will have the opportunity to hear directly about the US Office Market Update. Kenny Loh and Xavier Koh are particularly thrilled to be attending this event and gaining valuable insights firsthand.

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Highlighted Takeaways from the Session: Key Insights on US Office Market

1) Expecting strong momentum as companies encourage employees to return to the office

Currently, employee back-to-office attendance still remains low. Looking ahead, employers introduce new Return to Office (RTO) Mandates. Employers prefer their employees to be back in offices.

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2) Remote jobs openings declining

Companies now open up lesser remote jobs which might signal a preference for employees to be present in the office.

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3) Declining leasing activity in Q1 2023

Leasing activity shows a promising 37% increase from 2020 to 2022, but recent Q-o-Q decline of -10.7% signals waning momentum. As of now, the leasing levels have yet to fully recover to Pre-COVID Levels.

The rise in interest rates prompts occupiers to adopt a more defensive approach in leasing decisions.

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4) Lowest large-scale leasing activities for the recent quarter

It was surprising that Q1 2023 is the lowest leasing activities since the pandemic began. However, in Q2 prelim data, the leasing activities are picking up which might provide recovery signals even though it is still below the pre-pandemic average.

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5) Lease expiry remains high

The lease expiry within the office space remains high for the next few years. This is due to more short-term leasing deals that are done during the pandemic.

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6) Limited new office constructions which drive down the new office supply 

The reduction of new development was also due to increasing financing and production cost. In 2.5 – 3.5 years time, there might not be enough new quality development to absorb demand.

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Conclusion

The US Office Market faces several obstacles that impede its progress.

To envision a more favourable future for this market, we will closely monitor the following factors:

1. The actual end of the Interest Rate Hike by the Federal Reserve: This will enable investors and REIT managers to make more accurate forecasts regarding the expenses required to finance the current and future expansion of REITs.
2. Employers require additional time to determine the optimal blend of remote and physical work environments: This will allow them to make more informed decisions regarding longer lease periods.
3. Improvement in the valuation of US Office REITs through a more favourable leasing environment: This will occur when companies observe signs of their business picking up, leading to increased confidence and demand for office spaces.

During this uncertain period, it is prudent to invest safely and wisely by understanding the fundamental aspects of each REIT.

One year ago, I covered Manulife US REIT’s declining property valuation. However, MUST’s portfolio valuation has continued to decline. The recent earnings results have documented a -10.9% portfolio valuation decline y-o-y as of 31st December 2022, increasing its gearing ratio to ~49%. This is close to the gearing ratio limit of 50% for REITs. I have therefore asked the following questions, on how MUST can reduce its gearing ratio as well as stem the constant portfolio valuation declines.

MUST’s NAV trend since Q3 2016.

MUST’s Gearing Ratio trend since Q3 2016.

• What is the probable gearing ratio at the end of the year if: (1) a more reasonable cap rate used; and (2) if MUST is able to find new tenants to replace old ones who have decided to exit?
• The current valuation may be too conservative and planned for the worst-case scenario. Will MUST revalue its properties again in mid-year if there are significant changes in the assumption?

“We will be working to reduce our gearing through various options such as asset dispositions, distribution reinvestment plan, capital injection, discussions with capital partners and so on. We aim to bring our gearing below 45%. The strategic review is also ongoing, with healthy interest from a broad range of counterparties, including local and international developers, REITs and private equity. We expect to provide further updates on the strategic review in 2Q 2023. Meanwhile, the weighted average cap rate of MUST’s portfolio has increased slightly from 6.0% as at Dec 2021 to 6.3% as at Dec 2022. With more clarity on rate hikes and banks easing their lending, we should see some impact on cap rates. It is still early days. As for TCW, the tenant vacating from Figueroa by the end of the year, we have a couple of prospects who have toured the space a few times and we continue to engage them. For valuations, we will continue with yearly valuations in line with MAS regulations and our SREIT peers.” – a MUST spokesperson

MUST’s ESG ratings and transparency is commendable

Despite the poor performance in terms of portfolio valuation and gearing ratio, MUST’s strengths are in the areas of ESG. In the GRESB Real Estate Assessment, it has attained 5 stars, as well as the highest “Negligible” risk rating by Sustainalytics.

Kenny Loh is an Associate Wealth Advisory Director and REITs Specialist of Singapore’s top Independent Financial Advisor. He helps clients construct diversified portfolios consisting of different asset classes from REITs, Equities, Bonds, ETFs, Unit Trusts, Private Equity, Alternative Investments, Digital Assets and Fixed Maturity Funds to achieve an optimal risk adjusted return. Kenny is also a CERTIFIED FINANCIAL PLANNER, SGX Academy REIT Trainer, Certified IBF Trainer of Associate REIT Investment Advisor (ARIA) and also invited speaker of REITs Symposium and Invest Fair.