The Singapore stock market marked the end of 2021 with a positive set of news in the REIT space as MCT announced a merger with MPACT. In 2022, the landscape is vastly different, the year ends with Manulife REIT (MUST) announcing negative news as it received its results from its annual portfolio valuation.
Its valuation shrunk by 10.9% or US$237.4 million to US$1,947.0 million (versus US$2,184.4 million as at FY2021) due to market conditions.
The decline in property valuations were due to:
- Higher discount rates and capitalisation rates for certain properties reflecting risks posed by the volatile macroeconomic environment as well as idiosyncratic risks at the property level (i.e., higher vacancy or weak submarket fundamentals).
- Continued weakening of occupational performance in the submarkets where the properties are located due to slowdown in demand and leasing activity, which is leading to higher concession package assumptions needed to attract new or retain tenants, giving rise to higher leasing costs.
This led to MUST projecting an increase of its aggregate leverage ratio to approximately 49% while the interest coverage ratio (ICR) which is based on a trailing twelve months calculation (per regulatory requirement) is projected to decrease to 3.1 times.
This projection takes into consideration the current state of play and does not take into consideration future factors that cannot yet be determined such as further increase in interest rates or any significant decline to net property income.
This is just 1% below the regulatory limit of 50%. Do note that the regulatory limit of 50% is based on an ICR of at least 2.5 times. Should the ICR decrease below 2.5 times, the regulatory limit drops to 45%.
This decline in valuation has impacted the net asset value of the REIT by US$0.13 per unit. Based on MUST’s 1H22 financials, the NAV would decline by about 19%.
Base on the current state of play, financial covenants of existing loans are not expected to be breached despite the decline in valuation.
What caused MUST’s decline in valuations
MUST has 12 assets located in 10 submarkets, however, the decline was concentrated in a few assets and submarket with 73% of the valuation decline coming from 4 properties (Figueroa, Plaza, Exchange and Penn) in 3 submarkets (Los Angeles, Jersey, Washington DC)
| Asset | FY21 valuation | FY22 valuation | Change | % Change |
| Figueroa | 315.2 | 211.0 | -104.2 | -33.1% |
| Michelson | 317.0 | 292.0 | -25.0 | -7.9% |
| Peachtree | 212.9 | 205.0 | -7.9 | -3.7% |
| Plaza | 106.0 | 92.0 | -14.0 | -13.2% |
| Exchange | 324.0 | 290.0 | -34.0 | -10.5% |
| Penn | 177.3 | 156.0 | -21.3 | -12.0% |
| Phipps | 216.0 | 210.0 | -6.0 | -2.8% |
| Centrepointe | 112.7 | 101.0 | -11.7 | -10.4% |
| Capitol | 197.0 | 190.0 | -7.0 | -3.6% |
| Tanasbourne | 34.4 | 33.5 | -0.9 | -2.6% |
| Park Place | 106.9 | 103.0 | -3.9 | -3.6% |
| Diablo | 65.0 | 63.5 | -1.5 | -2.3% |
| Total | 2184.4 | 1947.0 | -237.4 | -10.9% |
MUST’s management shared that the decline in valuation were due to various factors such as expansion in capitalisation/discount rate and lower leasing activity.
The weighted increase to the capitalisation and discount rate for the entire portfolio was merely 0.4% to 0.5% although some assets such as Figueroa, its largest asset saw discount rates increasing by more than 1%. This either indicates that some of the submarkets are holding stronger than the rest or there could be more declines in valuation.
Although MUST is maintaining rental reversion guidance, they are expecting higher rent concessions and this has also impacted the valuation of the asset. In addition, potential vacancies due to the soft market has further impacted valuation.
MUST has also blamed the valuation due to sales comparables pulling down its valuations as some companies have sold their assets at fire sale prices.
What is MUST doing?
MUST has made it clear that its priority is to deleverage by way of asset sales.
The REIT manager has also engaged Citibank for a strategic and tactical review for the REIT.
In addition, the property managers in charged of MUST have also engaged JLL to execute property level improvements as well as look at potential partnerships.
What should unitholders expect?
We list a few things that unitholders can expect. Although some of the options are regarded as last resort options by MUST, we think it is important that unitholders are aware of some of these options.
1) Painful asset sale(s)
An asset sale is MUST’s preferred option.
With the latest property devaluations, using the 1H22 financials as reference, MUST’s net asset value is about $1 billion and its total asset is approximately $2b with borrowings at nearly $1 billion.
As a start, to stay within the regulatory requirement, MUST would likely aim to at least reduce gearing to 45% and below. This means they would need to sell at least $170 million to $200 million of assets or 10% of their total assets.
This means that MUST would either have to sell 1 or 2 properties depending on which property is being sold.
While one can always be hopeful that assets would be sold at or above book value, in this current market environment, the chances are slimmer than usual.
Although a disposal is regarded as more conducive than equity raising, MUST explained that this 4Q was not a good time to sell assets due to the weak sentiments. MUST actually walked away from some offers as the offers were not attractive.
With analysts expecting 1H23 to be weaker than 2H22, we wonder if MUST would be forced into a fire sale situation at the end of the day.
2) Equity Fund Raisings (EFRs)
MUST has various options to carry out EFRs. The management has shareholder approvals in place to carry out private placements up to 20% of the total units and rights/preference shares of up to a 50% limit.
Again, while one can be hopeful that the EFRs can be carry out at above current share prices (as current share prices are substantially below NAV), this is probably unlikely.
Assuming MUST is only able to sell one of the smaller properties, they would then have to make up the remaining shortfall with the EFR.
We note that the current share price of US$0.30 translates into a market capitalisation of US$534mil which makes any potential EFR highly dilutive.
3) Lower Distribution Per Unit (DPU) and Distribution Reinvestment Plan (DRP)
REITs that distribute at least 90% of taxable income each year enjoy tax transparency treatment by IRAS (subject to certain conditions). Individual investors who receive these distributions also enjoy tax-exemption treatment
MUST currently distributes 100% of taxable income, hence if they withhold 10%, they will be able to save up to $9 million. This would probably not move the needle all that much.
The other lever is for MUST to offer a DRP which is allowing the shareholders to automatically reinvest/convert their cash dividends into additional units in the REIT. With distributions of approximately $90million a year and the stock trading below NAV, this could be a meaningful option for the REIT.
4) A Sponsor backed rescue
MUST is sponsored by a subsidiary of the Manulife Group, a leading international financial services group providing financial advice, insurance and wealth and asset management solutions. It is probably clear to everyone that the sponsor is a reputable name with sizeable firepower.
MUST has explained that similar to sponsors of other local REITs, its sponsor recognises the need to step up and contribute to the sustainability of the REIT.
In the past, Sponsors of Singapore listed REITs have provided mandates to subscribe for excess units from EFRs or even provide loan funding to enable the REITs to repay lenders. Sponsors have also acquired properties from its REIT to support the REIT’s deleveraging process.
Closing statements
There is no doubt that a large portion of MUST’s woes is due to the systemic macroeconomic situation and new trends such as Working From Home. Due to the weak macro environment, tenants are deprioritising their office space needs as they grapple with higher inflation and borrowing costs.
The conflux of these issues have caused MUST’s properties to be devalued significantly. Hence, MUST has stepped up its game both on the strategic/tactical REIT level and also at the individual property level to figure out its options.
MUST has made reducing its gearing the top most priority and kept all options on the table such as asset sales, equity fund raisings, a potential distribution reinvestment plan and maybe even adjustments to distributions. Unitholders can also be hopeful of support from the Sponsor.
With the current economic climate, one may start to wonder if it is too little too late. although we think this is not the situation at hand, when the valuation of an entire portfolio decreases by 10.9%, 5 properties seeing double digit declines and 1 property with a shocking -33.1% decline, current unitholders are likely to go through a lot of pain before MUST is able to survive.
Potential unitholders should look at the rescue efforts from the Sponsor and should the Sponsor step up its game to a level comparable to other REITs or even outperform them, this would not only rescue the REIT but maybe even reduce the valuation discount attributed to foreign sponsors.
Unfortunately, if timely and appropriate action is not taken, we may see MUST become part of history.
