Lessons from Manulife US Reit’s troubles

THE sell-off suffered by Manulife US Reit (MUST) since news broke that its property portfolio has been devalued by a further 14.6 per cent felt very much like the “final capitulation” phase of a long and brutal slump.

As the market price of MUST’s units cratered, some analysts downgraded their recommendations and urged investors to flee. UOB Kay Hian dropped its target price from US$0.47 to US$0.165. DBS cut its target price from US$0.24 to US$0.10.

MUST closed Friday (Jul 28) at US$0.111, down 34.3 per cent since the fateful announcement.

The nervousness is understandable. The announcement on Jul 18 was not just another piece of bad news, but a loud warning that the beleaguered US office property real estate investment trust (Reit) might have passed the point of no return.

It could also raise questions about the prospects for other Reits that have relatively high gearing, or that are exposed to potentially weak segments of the global property market.

The latest decline in the value of MUST’s property portfolio is on top of the 10.9 per cent markdown announced at the end of last year – which pushed the Reit’s gearing to just a hair below the statutory ceiling of 50 per cent.

MUST’s gearing has now further inflated to about 57 per cent. It is in breach of one debt covenant, and at risk of eventually breaching other debt covenants.

The manager of MUST also flagged the possibility of the Reit being restrained from making further distributions to unitholders and, consequently, having to pay additional taxes.

The value of MUST’s portfolio as at Jun 30 was US$1,633.6 million.

Where does this leave MUST’s unitholders? One reason many analysts and investors did not immediately abandon MUST even as its troubles mounted over the past year is that the market price of its units already seemed so depressed.

The risk of a dilutive recapitalisation exercise or a fire sale of assets appeared to be more than fully reflected in the steep discount at which the Reit was trading to its net asset value (NAV).

MUST’s manager and sponsor group failed to make the most of this support while they had it, though. For one thing, they did not quickly recapitalise MUST when signs first emerged that the US commercial property market was souring.

The only transaction to fend off trouble that MUST has completed is the sale of a property called Tanasbourne to its sponsor group for US$33.5 million in April.

A proposal to sell a property called Phipps Tower was announced in May. The same month, the exclusivity period for a recapitalisation plan involving Mirae Asset Global Investments lapsed.

The big question now is whether pressure from MUST’s creditors will force its manager and sponsor group to urgently take meaningful steps to preserve the Reit’s viability, or to simply throw in the towel.

Commercial property slump

Whatever MUST’s manager and sponsor group decide to do, this sorry episode holds lessons for the managers and sponsor groups of other Reits that have slumped over the past year in the face of tightening monetary policy around the globe.

This past week, the US Federal Reserve and European Central Bank hiked their respective benchmark rates by a further 25 basis points, to levels not seen in more than two decades.

US regulators also mooted more stringent capital requirements for financial institutions, following a string of runs on mid-sized banks earlier this year.

Against this backdrop, concerns of a big shake-out in the commercial real estate sector are growing. Indeed, the announcement made by MUST’s manager on Jul 18 suggests the commercial property slump in the United States is deepening and widening as the effects of higher discount rates and vacancy levels manifest themselves.

The valuation of MUST’s property on South Figueroa Street in Los Angeles – one of its most prominent holdings – suffered a 17.5 per cent decline in H1 2023 after being marked down 33.1 per cent at the end of 2022. The value of this single asset has fallen 44.8 per cent since end-2021, from US$315.2 million to US$174 million.

Another property, on Pennsylvania Avenue in Washington DC, had its valuation reduced by 20.5 per cent in H1 2023. This asset had already been revalued downwards by 12 per cent in 2022. All in, this property has experienced a valuation decline of more than 30 per cent since end-2021, from US$177.3 million to US$124 million.

Then there was Phipps, a property on Peachtree Road in Atlanta that is supposed to be sold back to MUST’s sponsor group. This property held up well in 2022, falling only 2.8 per cent in value. In H1 2023, however, its valuation was slashed by 15.2 per cent to US$178.2 million.

Time to tap unitholders

Such volatility in commercial real estate valuations may be shocking for investors in Singapore, where property prices only ever seem to go up. But other locally listed Reits with exposure to US commercial property are trading at levels that seem to imply looming devaluations for their portfolio assets.

In particular, Prime US Reit has slumped 52.6 per cent since the beginning of this year and is now trading at a 73.3 per cent discount to NAV. The Reit owns office properties across the US, and ended last year with a relatively high gearing level of 42.1 per cent.

Keppel Pacific Oak US Reit also holds US office properties, but its gearing stood at 38.4 per cent as at Jun 30. Its units have fallen 26.1 per cent since the beginning of this year, and are trading at a 56.4 per cent discount to NAV.

United Hampshire US Reit has a portfolio comprising retail and self-storage properties located across the east coast of the US. It has a relatively high gearing of 42.6 per cent, and its units are trading at a 41 per cent discount to NAV.

If there is any likelihood these Reits will suffer significant markdowns in the value of their properties, their managers and sponsor groups should take immediate steps to meaningfully reduce their gearing.

While many existing unitholders will probably not be happy about being tapped for cash, a timely recapitalisation exercise would put these Reits in a stronger position to cope with any devaluation of their portfolios and to make acquisitions in the wake of the unfolding commercial property slump.

This could transform the market’s perception of these Reits, and make them more appealing to investors on the hunt for bargains.