(Sept 11): Manulife US Real Estate Investment Trust, which stands out from the dozens of other locally listed REITs for its US-focused office portfolio, has proposed to acquire a second property in just three months. And, it is once more raising money by issuing new units to fund the expansion of its portfolio.

On Sept 2, the REIT’s manager said it would pay US$313.2 million ($422.1 million) for 10 Exchange Place, an office building located in Jersey City, across the river from Manhattan.

To partially pay for the new asset, the REIT will raise gross proceeds of US$208 million via a rights issue of 299.3 million units at 69.5 US cents each. The rights issue, which will be offered to unitholders at a ratio of 41 for 100, represents a 28% discount to Manulife US REIT’s closing price of 96.5 US cents on Aug 31, the last trading day before the acquisition announcement. The rights price is also 21.6% below the theoretical ex-rights price of 88.6 US cents.

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The immediate reaction from the market was not positive. The proposed acquisition-cum-cash call wasn’t liked by all investors.

When the market opened on Sept 4, the unit price of Manulife US REIT dropped 4.5 US cents to as low as 92 US cents, before closing the day at 94.5 US cents. It closed at 94 cents on Sept 7, amid overall market jitters caused by North Korea. Since the beginning of the year, the REIT has gained 13.3%. It is also up 13.3% from its May 2016 IPO price of 83 US cents.

Manulife US REIT listed with an initial portfolio of three office properties, two of which are in California — one in Los Angeles and the other in Irvine. The third property is in Atlanta, Georgia. Now, Manulife US REIT is diversifying its portfolio to the East Coast of the US.

On June 19, its manager said it would pay US$115 million for 500 Plaza Drive, located in Secaucus, New Jersey. This acquisition was partly funded by a placement of 97 million new units that raised US$80.5 million. The placement price of 83 US cents, same as the IPO price, was a 7.3% discount to the June 19 closing price of 89.5 US cents.

Jill Smith, CEO of Manulife US REIT’s manager, says the latest acquisition, of 10 Exchange Place, was too good to turn down. According to her, the freehold property is exposed to the thriving vicinity of Northern New Jersey, where many big US financial corporations have set up offices at rents that are significantly lower than in Manhattan. Some are now calling this area “Wall Street West”.

Moreover, the acquisition is likely to be immediately yield-accretive. On a pro forma basis, for the period of May 20 last year (the day the REIT was listed) to Dec 31, the acquisitions of 500 Plaza Drive (including the effect of the placement) and 10 Exchange Place (including the effect of the heavily discounted rights issue) would have boosted the REIT’s yield from 5.96% to 6.23%.

The acquisition of 500 Plaza Drive (including the effect of the placement) alone would have boosted the yield from 5.96% to 6.1%.

10 Exchange Place was built in 1988 and has a net lettable area of 730,598 sq ft. It faces the Hudson River and has an obstructed view of Manhattan. The newly rebuilt World Trade Center is located directly across it and is connected via the subway one stop away. Other transport links provide easy access around.

Manulife US REIT’s sponsor, John Hancock — the trading name of Manulife Financial Corp in the US — bought 10 Exchange Place in 2011 for US$285 million.

The purchase price of US$313.2 million is lower than two valuations obtained for the transaction. RERC valued the property at US$336 million; Colliers came up with a valuation of US$330 million. With acquisition costs — which include US$2.4 million in acquisition fees as well as fees related to the rights issue — the total bill will come up to US$332 million.

“This is just too good to miss,” says Smith, at a briefing on Sept 4. “This acquisition solidifies the geographical diversification that we’ve talked about since the IPO.”

Expecting higher rents Citigroup was previously a large tenant at 10 Exchange Place, taking up around a third of the space, although some of that was shadow occupancy, as the bank streamlined operations and paid rent on space it did not use.

The property now has an occupancy rate of 93.1% and the weighted average lease expiry is 5.7 years. It has a total of 25 tenants. The largest tenant is e-commerce giant Amazon.com, which contributes 18.2% of total rent.

Other key tenants include insurer ACE, part of listed entity Chubb, air-conditioner manufacturer Daikin Industries and enterprise software company Citrix Systems.

Jeffrey Wolfe, chief investment officer at Manulife US REIT’s manager, says leases contributing 6% of the cash rental income at the property are due to expire by year-end. This creates an opportunity for the REIT to raise rents on this space. The average annual rent across the whole building is currently US$38.18 psf.

In 1Q2017, space at similar waterfront properties was fetching US$46.34 psf. “There’s plenty of runway to go,” Wolfe says.

He also points out that 10 Exchange Place is adjacent to a subway station, which should make it more attractive than similar buildings nearby. “A block or two away doesn’t seem significant, until it is zero degrees and snowing.”

The 30-storey building is double the height of buildings next to it. “Our view’s much better,” he adds.

Manulife US REIT expects to spend US$3 million to refurbish the building’s lobby, and an additional sum for other minor works throughout the rest of the building. Wolfe says there will be limited new supply of office space in the vicinity.

He notes that the REIT is paying just under US$430 psf for the property, which is well below the current cost of constructing a new building of about US$600 psf.

Furthermore, all the waterfront sites have been taken up, which means new construction cannot take place without tearing down an existing building. “That makes your cost even higher,” he says.

Bigger REIT, more fees When Manulife US REIT was listed, its portfolio was valued at US$799 million. Following the acquisition of 500 Plaza Drive, its portfolio grew to US$973.5 million. Now, the acquisition of 10 Exchange Place will expand the portfolio further to US$1,306.5 million.

The most valuable property remains Michelson, its property in Irvine, which will account for 26.2% of the value of the enlarged portfolio. 10 Exchange Place, which will constitute 25.5%, is a close second. The REIT’s property in Los Angeles, called Figueroa, will account for 24.8% of the expanded portfolio’s value.

Meanwhile, the latest acquisition will diversify the REIT’s tenant base. Currently, the REIT’s top 10 tenants contribute 64.1% of its cash rental income. With the acquisition, the top tenants will contribute only 47.7%. Interestingly, seven of the current top 10 tenants by cash rental income are law firms. After the latest acquisition, only three of the top tenants will be law firms.

Of course, investors really benefit only if a REIT’s distribution per unit rises or if the market value of those units rise.

Investors who buy REITs for their yield might also be averse to being tapped for cash to fund the acquisition of new properties. So, even when acquisitions are yield-accretive, they tend to be scrutinised.

Is the latest acquisition proposed by Manulife US REIT really beneficial to investors, then?

Jag Obhan, chief financial officer at Manulife US REIT’s manager, refutes suggestions that the latest acquisition might be an attempt to bulk up the portfolio too quickly.

He points out that the REIT’s management fee of 0.75% of the purchase price, which translates into US$2.4 million, will be paid in the form of new units that the manager will not sell for a year.

The REIT’s management fee is pegged at 10% of its distributable income, he notes, rather than being linked directly to the size of the portfolio.

The manager also stands to earn a performance fee equivalent to 25% of the growth in the REIT’s DPU multiplied by the weighted average number of units in issue for the financial year.

Manulife US REIT’s manager will seek permission from unitholders for the proposed acquisition of 10 Exchange Place and rights issue at an extraordinary general meeting scheduled for Sept 19.

Manulife US REIT acquires second asset in three months, taps unitholders for cash

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