Company Update: Narrowing rental decline upon renewal
- Portfolio occupancy remains high at >95%
- Negative rental reversion narrowed to 4-5%
- >60% of leases expiring in FY22 have been renewed/re-let
Amid the economic slowdown, certain investment or trading companies at The Metropolis Tower in Hung Hom did not renew their leases upon expiry in 1H22. This brought the current occupancy at The Metropolis Tower lower at >90% from Dec-21’s 98.2%. Despite weaker occupancy at The Metropolis Tower, portfolio occupancy maintained high at 95-96% (Dec-21: 97.7%) as the occupancy of other properties remained largely stable.
Leasing enquiries and on-site inspection activities have recovered on the back of improved pandemic situation since Apr-22. Nonetheless, demand from MNCs remained subdued amid sluggish economy and global travel restrictions. In 2022, c.40% of the leases in terms of gross rental area are scheduled for expiry, with >60% due in 1H22. Prosperity REIT has concluded 60-70% of these expiring leases in 2022. Retention rate is high at c.70%.
Aided by positive rental reversions for certain tenants at Prosperity Place and Trendy Centre, overall rental decline upon renewal further moderated to 4-5% from FY21’s 7.7%. Nonetheless, rental reversion at The Metropolis Tower stayed in the negative territory with the lack of new demand from MNCs.
Prosperity REIT has granted rental concessions to semi-retail tenants at Prosperity Place and Trendy Centre, whose businesses were severely impacted by tightening of social distancing measures led by the fifth wave of pandemic. The amount, albeit higher than that of 2020, remains insignificant compared to the overall rental income of the REIT.
Prosperity REIT is in discussions with banks on the refinancing of HK$1.5bn term loan maturing in Nov-22. Credit margin is expected to be 40-50bps higher than the existing one. In 1H22, Prosperity REIT entered into more interest rate swaps (IRS), raising its current hedging ratio up to >70% (Dec-21: 70%). With a portion of IRS scheduled to expire in 2H22, Prosperity REIT’s hedging ratio is set to decline to 50-55% by the end of 2022. Yet, with >50% of interest cost fixed, concerns on impact on financing costs due to interest rate hikes should not be overplayed.
Prosperity REIT is conducting enhancement works at The Metropolis Tower. Renovation works at the lobby floor has been completed while facelift at office floors is underway. With budgeted capex of HK$40m, the entire enhancement work is expected to complete by the end of 2023. Other AEI plans include the installation of solar panels at The Metropolis Tower, 9 Chong Yip Street and Trendy Centre.
YTD, Prosperity REIT has bought back 14.9m shares for HK$42.8m or HK$2.88 per share on average. This should help offset DPU dilution led by lower rental income.
YTD, unit price of Prosperity REIT retreated by 22%, underperforming its peers by 3-15%. Prosperity REIT is trading at 6.9-6.3% distribution yield for FY22-23. This translates into yield spread of 4.2-3.6%. Despite the global economic downturn, portfolio occupancy remains high which points to income resilience. Negative rental reversion is also tapering off. Maintain BUY at this stage with DDM-based TP of HK$2.78.