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What are MUST’s options as gearing nears 50%?

Jovi Ho
Jovi Ho • 5 min read
What are MUST’s options as gearing nears 50%?
Peachtree, Manulife US REIT's Class-A office building in Atlanta. Photo: Manulife US REIT
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First, the bad news: At last August’s release of Manulife US REIT’s (MUST) results 1HFY2022 ended June 2022, the REIT’s manager revealed that its assets would henceforth be valued at the end of each calendar year instead of biannually.

On Dec 30, 2022, MUST revealed that the real estate value of its portfolio declined 10.9% y-o-y to US$1.95 billion ($2.6 billion) as at the end of 2022. MUST attributes this to the higher discount rates and capitalisation rates for some of the REIT’s properties, citing “idiosyncratic” risks at the property level, such as higher vacancy rates and weak submarket fundamentals.

Among MUST’s 12-strong portfolio, the steepest decline came from its Figueroa property in Los Angeles, California, whose value fell 33.1% y-o-y to US$211 million. Management blames this on the property’s two largest tenants — Quinn Emmanuel and TCW Group — with the former executing a renewal and downsizing while the latter plans to vacate at the end of their lease term on Dec 31, 2023.

The valuation decline brought about a spike in gearing to 48.8% from 42.5% in 3QFY2022, breaking a previous high of 42.8% in March 2022. As of April 2020, the Monetary Authority of Singapore’s leverage limit for S-REITs is 50%, up from 45%.

Taming MUST’s persistently high gearing is a “primary focus”, said executive officer (CEO) of MUST’s manager Tripp Gantt at the release of the REIT’s 3QFY2022 results. Then, management announced a strategic working group of board and management members to explore a “potential business pivot, strategic partnerships, joint ventures and mergers and acquisitions”.

This could even see MUST breaking out of the office sector into industrial and multifamily assets in the US, said Gantt in November 2022. On Nov 25, 2022, MUST appointed Citigroup Global Markets to “undertake a review of a variety of options available to Manulife US REIT to enhance unitholder value”. The consultants will submit their recommendations by 2Q2023.

See also: US office REITs climb a wall of worry

“Our ultimate objective is to find a partner who will help us achieve the strategic things that we’ve been talking about for a while now: Potentially pivoting to higher growth types of tenants and asset classes,” says Gantt at the release of MUST’s FY2022 ended December 2022 results. “We’ve been reaching out to folks who can provide a pipeline of assets, asset management expertise, the capital needed — all those things.”

Looking at options

MUST’s manager is in active negotiations with its sponsor for a potential asset disposition, likely a stake sale of its assets. “What I’ll say is, we’re more engaged with our sponsor right now than ever have been; they are really in the trenches with us at the moment,” said CEO Tripp Gantt at the Feb 9 results briefing.

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Management says two prospective deals fell through last year. “We were encouraged that we got to the point of negotiations in those properties. I can’t divulge which properties because we may still want to look at those options, and I wouldn’t want to give up our competitive position on negotiations,” says Gantt. “The debt markets are hammering buyers at the moment. That’s what’s holding up the transactions.”

While another option to shore up capital is through a dilutive rights issue, management says this is one of its least preferred options. “One of the downsides about selling an asset at a steep discount is that you crystallise that loss,” says Gantt. “Rights issues do have an impact on share price, but it gives you the ability to stabilise your balance sheet and potentially have a unit price increase in the future; I think that’s something you can recover from. Which is in the best long-term interest of unitholders? It’s a balancing act here.”

Any equity fundraising will “always be one of the last options”, says deputy CEO Caroline Fong, who adds that management has been working on potential divestments since 2Q2022.

Meanwhile, the REIT has cut its payout ratio to 91%. As a result, DPU of 2.14 US cents for the 2HFY2022 ended Dec 31, 2022, came in 18.6% lower y-o-y.

Management has obtained a loan for US$105 million, due for refinancing in June. Aside from this, there are no major refinancing needs in 2023. Weighted average interest rate rose to 3.74% as at Dec 31, 2022, from 2.82% at the end of 2021, while fixedrate loans fell to 77.3% from 86.5% over the same period.

Headwinds priced in

In over a year, MUST’s unit price has fallen more than 55% to 30 US cents as at Feb 14. Even with the worst-case scenario of a rights issue, MUST’s unit price could still offer an 8% yield, say DBS Group Research analysts Rachel Tan and Derek Tan.

“Headwinds are largely priced in, and the share price is close to the bottom,” the DBS analysts in a Feb 10 note. “We believe the sponsor’s support to acquire MUST’s assets will be a win-win approach for both and a best-case scenario for MUST.”

RHB Group Research analyst Vijay Natarajan agrees, noting that MUST is trading at a 40% discount and offering a 14% yield. “We believe management is taking the right steps by actively working with its sponsor to lighten its debt while simultaneously exploring options with third parties, which, if successful, should bring the much-needed relief and stabilise the REIT.”

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