OIR: Manulife US REIT – Buy Fair Value US$0.69

Changing office trend

1H22 DPU declined 3.3% YoY to 2.61 US cents
Downsizing of tenants
Expecting low to mid single digit positive rental reversion in 2022

Investment thesis

Manulife US REIT’s (MUST) 1H22 distribution per unit (DPU) dropped 3.3% year-on-year (YoY) to 2.61 US cents due to higher vacancies at existing properties and an enlarged unit base from private placement, in-line with our expectations. Physical occupancy rate at MUST’s properties remained subdued at 28% as at 11 Jul 2022, as compared to 25.3% in 1Q22. As at 30 Jun 2022, portfolio occupancy was at 90.0% (-1.7 percentage points (ppt) quarter-on-quarter (QoQ)) due to nonrenewals of three large tenants. Rental reversion for 1H22 came in at +1%. While management continues to expect positive low to mid single digit of rental reversion for 2022, they noted that leasing activity and office demand have slowed down in the US. MUST benefitted from a flight to quality which remains the dominant trend of the office market. However, tenant space needs remained unclear, and most tenants are still downsizing which is likely to continue. We trim our DPU estimates by 3-7% for FY22-26 on lower occupancy estimates. After adjustments, our fair value estimate decreases from USD0.77 to USD0.69.

Investment summary

• 1H22 DPU met expectations – MUST’s 1H22 gross revenue and NPI grew 10.6% and 2.8% YoY to USD100.4m and USD57.6m, respectively, driven by additional contributions from acquisitions, lower renal abatements of USD200k (vs USD2m in 1H21), and higher carpark income. However, the growth was
partially offset by lower rental income from existing properties due to lower occupancy rates and the
absence of credit loss reversal. 1H22 DPU dropped 3.3% YoY to 2.61 US cents due to an enlarged unit
base from private placement, representing 48% of our initial expectations, in-line.

• Portfolio occupancy fell 1.7 ppt QoQ to 90% – Physical occupancy rate at MUST’s properties remained subdued at 28% as at 11 Jul 2022, as compared to 25.3% in 1Q22. As at 30 Jun 2022, portfolio occupancy
was at 90.0% (-1.7 ppt QoQ) due to non-renewals of three large tenants. MUST is in active discussions with the prospects to backfill the space. TCW Group and Quinn Emanuel, two of MUST’s top 10 tenants had informed MUST of their non-renewal/downsizing decisions. TCW accounts for 3.8% of MUST’s gross
rental income (GRI) indicated that they will vacate the space when their lease expires in Dec 2023 to
avoid major renovation. Quinn Emanuel (2.9% of GRI) will downsize by 71k square feet (sq ft) effective 31
Aug 2022 but will renew the remaining 64k sq ft for 5.4 years from Sep 2023 with +2.5% rental reversion.

• Exploring opportunities to reinvent office space – MUST executed 192,000 sq ft of space in 1H22 with
+1% rental reversion (1Q22: +3.9%; 2Q22: flat). While management continues to expect positive low to mid single digit of rental reversion for 2022, they noted that leasing activity and office demand have slowed down in the US. Tenant space needs remained unclear and most tenants are still downsizing. MUST expects the downsizing trend to continue as hybrid working models will stay and impact space needs. Management believes hotelisation of office could be the new normal ahead. MUST is partnering with bestin-class flex operators, e.g. Flex by JLL, to explore opportunities to provide flexible office solutions and reinvent office space.

• Fair value estimate of USD0.69 – We believe MUST will benefit from a flight to quality which remains the dominant trend of the US office market, and the impact of vacancy risks will be buffered by its low
lease expiry profile (4.8% GRI in 2H22 and 10.1% of GRI in 2023). We trim our DPU estimates by 3-7% for FY22- 26 on lower occupancy estimates. After adjustments (risk-free rate: 3.5%; cost of equity: 8.5%), our fair value estimate decreases from USD0.77 to USD0.69

ESG Updates

• Manulife US REIT’s (MUST) ESG rating was upgraded in Dec 2021, mainly due to its robust efforts to further increase the proportion of green-certified buildings in its portfolio (89% vs the industry average of 37.8% in 2020). Additionally, MUST falls into the highest scoring range relative to global peers in terms of corporate governance. However, MUST shows lagging efforts to attract and retain talent relative to peers according to research.