Previously we shared about 7 high quality REITs which provide rising dividends and long-term capital gains.
Now we want to talk about REITs that we believe are not worth the risks.
One such REIT is Manulife US REIT (MUST).
Just last week, MUST management reported that the valuation declined by 10.9% and that the gearing ratio has reached 49%.
For explanation sake, gearing ratio is calculated by dividing debt by total assets. A drop in valuation will lower the value of total assets. When the numerator (debt) remains the same and the denominator (total assets) goes down, the gearing ratio shoots up.
This is a cause for alarm because the legal requirement was for the gearing ratio to be below 50%.
MUST’s gearing is too close to the limit for comfort. What if valuation falls further?
Moreover this gearing limit of 50% isn’t permanent. It was raised from 45% to 50% during the Covid period. The Monetary Authority of Singapore (MAS) can lower it back to 45% if they deem fit. In that case, MUST would have failed the requirement.
But why is MUST’s valuation dropping?
MUST holds a portfolio of Grade A office buildings in the U.S. When Covid struck, many of the workers moved home to work. This trend didn’t fully reverse after Covid measures were lifted.
Work from home became a permanent trend in the U.S. The occupancy in these Grade A office started to go down.
Besides this issue, interest rate has risen and so are the financing charges. With more retrenchment and an economic slowdown looming, the valuers decided to lower MUST’s valuation significantly.
The likelier options are for MUST to sell some properties and/or to do a rights issue.
Selling properties and repaying the loans would be able to pare down debt.
Doing a rights issue increases the equity value and reduces debt proportionately.
But either option is going to be painful for unit holders.
This is because the properties are likely to sell for cheaper prices since valuations have declined, market sentiments are weak, and that buyers might push for deeper discounts.
Rights issue is costly now because the price-to-book ratio is at 0.4. This means that the issue price is likely to be significantly below the value of the properties, thereby diluting the share price further.
MUST is caught between a rock and a hard place. MUST cannot afford to do nothing. And yet, any solution is likely to hurt unitholders one way or another.
Hence, we believe that REITs like MUST are not worth the risks at this point in time.
Other REITs that may eventually run into issues could be Prime US REIT, Keppel Pacific Oak US REIT (KORE) and ARA US HTrust.
They are all based in the US and are subjected to the same market forces. Prime US REIT would be most similar as they own grade A office.
KORE’s properties are targeted at tech workers but even so, tech companies are firing which would affect KORE too.
ARA US HTrust owns hotels but the recovery has been slow. They have not gone back to pre-Covid operating levels yet. And now they have to contend with higher financing charges and a slower economy.
Sometimes in investing, it is not only about buying good stocks, but also to avoid the poor ones.
