DBS Group Research analysts Rachel Tan and Derek Tan are remaining positive on US Office S-REITs despite the recent slip amid fears of rate hikes due to the more optimistic outlook on the US economy, and expectations of a quicker and stronger recovery.
As macroeconomic data points towards recovery, the brokerage’s chief economist has upgraded this year’s US growth forecast to 6% from 4.5% previously.
“Our economists believe that the Fed is likely to upgrade its growth outlook at its next Federal Open Market Committee (FOMC) meeting on March 17,” write the analysts in a March 12 report.
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On the US Office REIT sector, the analysts “believe US Office S-REITs which are currently trading at deep valuations – c.9% yield (above 1 standard deviation [SD]) and yield spread of c.7% remain attractive."
“On a P/NAV basis, the US Office S- REITs are trading close to 1x P/NAV, at their historical average,” they add.
In addition, “rotational interests into risk-on/recovery plays as seen in the US Office peers should drive the next leg of re-rating as the US economy progressively recovers from the pandemic.”
“Despite pricing in both a 10% cut in estimates and US 10-year bond yields rising to 2%, the yield spread of 5.5% is at historical average,” they add.
Share prices of US REITs have trended upwards since the discovery of the Covid-19 vaccine.
Despite being a laggard initially, the analysts note that share prices of both US Office S-REITs and US Office regional office peers are at similar levels compared to pre-Covid-19 levels, and have re-rated close to 80% of pre-Covid-19 levels recently.
“Among the US Office S-REITs, KORE has been the top performer since December 2019 led by the inclusion into MSCI Singapore Small Cap Index while MUST has underperformed its peers since December 2019,” they write.
In addition, US Office REITs with regional offices are more resilient and outperformed those with gateway offices.
Based on historical trends, US Office S-REITs typically trade at a higher yield compared to its US Office peers’ funds from operations (FFO) yield.
“Given the diverging trends between the US Office REITs vs the US Office S-REITs recently, we compared the US Office REITs vs the US Office regional peers and note that the yield spread between the two has widened to 2.4 percentage points vs historical average of 0.9 percentage point,” note the analysts
Amid the “bleak environment”, the analysts say they see a silver lining for the US Office S-REITs to overcome near-term headwinds, including the optimism that the US could return to normalcy quicker than expected, suburban office markets remaining more insulated and less impacted, as well as healthy levels of occupancy in FY2020.
“Prime US REIT and Manulife US REIT (MUST) both have less than 10% of lease expiries in FY2021 of 8.8% and 4.4% respectively. Prime US REIT has the lowest total lease expiries in FY2021 and FY2022 of 16.9% vs MUST and Keppel Pacific Oak US REIT (KORE) at above 20%.”
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“Based on JLL’s outlook/commentary, key submarkets that are expected to see a recovery contributes approximately 37% and 33% of Prime’s and MUST’s net property income (NPI) respectively. However, we note that there are positive catalysts/green shoots seen in the Seattle market in 2H2021 which contributes c.45% of KORE’s NPI,” they say.
The analysts have maintained “buy” on Manulife US REIT (MUST), Prime US REIT and Keppel Pacific Oak US REIT (KORE) with target prices of 90 US cents, US$1 and 85 US cents respectively.
Units in MUST, Prime and KORE closed 69.5 US cents, 79.5 US cents and 69 US cents respectively on March 12.