SINGAPORE (June 24): US office REITs are enjoying strong portfolio resiliency amid the economic uncertainty of Covid-19. DBS Research’s Rachel Tan and Derek Tan have reported healthy rent collections of more than 90% in the April-May period and portfolio occupancy of 94-97% as of 1Q20. On top of this, expiring leases for FY20 have fallen 4-6% after factoring leases renewed and signed in 1Q20, suggesting stable cash flow going forward.
PRIME US REIT, in particular, has experienced near-perfect rental collection during the lock-down as even at-risk tenants have continued to pay their rents. “Prime continued to display the quality of its portfolio and management capabilities with successfully collected 99% of its rents in Apr and May during the lockdown period, including at-risk tenants,” say the analysts. There have so far been few requests for rental relief from the REIT’s tenants.
The REIT is a geographically diversified portfolio of 11 Class A freehold prime office assets in the US. Strongly weighted to major US cities, around 70% of its portfolio comprises properties in Denver, Salt Lake City, Atlanta, Washington D.C. (Suburban Maryland and Virginia) and San Francisco Bay Area (Oakland). Its net leasable area (NLA) of approximately 3.4 million square feet is valued at US$1.2 billion (S$1.6 billion).
Notable among PRIME’s high-risks tenants are WeWork and Regus, with whom the REIT is working towards a resolution. WeWork, a prominent co-working space that has fallen on hard times, has provided PRIME with letters of credit, corporate guarantees and a security bond securing its outstanding US$2 million of rent -- nearly a year’s worth of arrears. The REIT does not expect rental stress associated with oil and gas companies despite falling oil prices, with its largest tenant Apache’s lease only expiring in 2024.
“We believe PRIME’s strength lies in the fact that its cash flows are relatively stable and resilient. This arises due to its long weighted average lease expiry (WALE) by NLA of c.5.1 years (as at Dec 2019), reflecting the typical lease tenure of 5-10 years,” say Rachel and Derek Tan. PRIME maintains a sustainable staggered lease expiry profiles with no more than 20% of leases by cash rental income and NLA expiring in a given for the next eight years. PRIME’s low 33.7% gearing remains well below MAS’s 50% threshold and is expected to remain below 40% in the near-term, with no refinancing required until 2024.
The analysts see most tenants renewing their leases rather than moving out, with retention rates likely to remain high. While acquisitions have currently been paused, PRIME will not rule out capitalising on good opportunities that may arise amid the difficult economic situation, especially since its low gearing provides lots of debt headroom for such purchases. Embedded rental escalation of around 1-3% (average 2.1%) in 98.3% of PRIME’s contracted leases as of 2019, could moreover offer a valuable organic growth profile for the REIT.
While the REIT’s distributable income (DI) exceeded analyst projections by 13% in 1Q20 due to contributions from newly-acquired assets, lower interest rates and higher rents, distribution per unit (DPU) is nevertheless marginally lower than expected. This was despite revenue and net property income (NPI) beating projections by 4.1% and 6.7% respectively. Still, Derek and Rachel Tan are not unduly worried about dividend earnings being unduly hit.
“Rest assured! It is mandatory for US Office S-REITs (via trust deed) to have a minimum 90% dividend payout,” they tell investors, pointing out that PRIME itself -- a newly-listed REIT -- has committed to a 100% dividend payout in FY20. Low interest rates also bode well for the yield curve for US Office S-REITS, as the Fed looks set to maintain such low interest rate conditions for the foreseeable future. The analysts believe that earning visibility and accretive acquisitions will improve investor confidence in PRIME and translate into a re-rating of its share price.
As lockdown measures ease across the US, firms will begin returning to office slowly, with Wall Street firms already seeing workers trickling back into their offices despite slower movement from technology companies. Landlords are working to improve cleaning in common areas and introduce new technology like automatic cleaning to ensure tenant safety. Safe distancing measures introduced to encourage social distancing may see more short-term leases signed.
“Every crisis presents opportunities. We believe transaction markets could eventually pick up as activities return to normalcy. As share prices remain at these levels or higher, opportunities will eventually arise,” conclude Rachel and Derek Tan. Still, while they have maintained their “buy” call on PRIME, they have lowered their target price from $1.05 to $1.00 to factor in caution regarding the US economy. Yet with dividend yield staying at around 8%, they believe the stock offers attractive value for dividend investors looking for exposure to the US real estate market.
As of 3.50pm, Prime US REIT is currently trading up 0.02 points in US Dollars at a price of US$0.825.