11 Deeper Things I Learned about Manulife US REIT
- Original Post from Investment Moats

Manulife US REIT announced their Q3 2018 result not too long ago and generally, it is not filled with surprises.

However, much of the attention was taken away from the results, the focus being on its falling share price.

The current share price (2018 Nov 23) is US$0.77. If we annualized the adjusted DPU of US$0.0152 we get a dividend per share of US$0.0608.

The dividend yield is 7.89%. Rather juicy.

In my opinion, the share price was weigh down by a combination of

  1. Rising interest rate environment generally challenging for REITs

  2. Volatile stock markets these few months

  3. Fundamental uncertainty due to possible reduction in distributable income

Gross revenue improved 75% as did net property income. The income available for distribution improved by 64.9% versus last year.

The main reason for the rise is due to contribution from an enlarged property base offset by a large number of outstanding shares, due to rights issue.

The DPU rose 33.6%, but this is very misleading owing to a few preferential offering and rights issue. This enlarged the amount of outstanding shares.

It is very distorted but let us be clear that if you did not subscribe to the rights issue, you would not have been DPU accretive.

However, had you subscribed the adjusted DPU of 1.52 cents, you should be accretive.

The REIT also signed 8 leases with an average of 13.5% rental reversion. This includes one mid term rent review.

This article is also another deeper dive of what I could gather from the management.

It is strongly advised to read the following write ups so that this article make more sense:

  1. My Manulife US REIT Analysis

  2. My insights after meeting the management

And by the time you have finish reading this article, you should have a very good idea about how the management operating, think about things.

We will be covering:

  1. Subtle hints on Michelson’s lease renewal status

  2. Impact of Co-Working Spaces

  3. Net Lease, Gross Base Stop Leases

  4. Flow through of rental escalation

  5. Clarification on average rental escalation

  6. Clarification on WALE of new renewals

  7. Difference between CBD vs Suburban, Class A vs B vs Trophy

  8. Ability to Switch to a quarterly dividend payout

  9. Explaining the tax issues more in detail

  10. Discussing the capital structure

  11. Discussing rights issue, placements and preferential offering

  12. Valuation and summary

Of Michelson’s 2019 Lease Renewal Status

30% of Michelson’s leasing income is expiring in 2019.

That is a sizable expiry and for shareholders, this is probably something to be concerned about. If this is an expiry by some of the local office REITs, shareholders are less concerned because they have a good idea about the leasing climate in Singapore and Hong Kong.

USA leasing presents a different culture, and when you have a REIT with properties there, you do not know if they can execute well.

Even before we can plant that question, management updated that they have been negotiating with the key tenants (Hyundai Motor Financials and Jones Day mainly) for the past year. They have their fingers crossed that there will be some updates in the Q4 2018 result.

The Impact of the Rise of Co-Working Spaces to Office Landlording

One analyst asked about the management’s opinion on the rise of co-working space.

Manulife is very familiar with this concept.The management was rather cautious about having a large tenant base that is based upon co-working tenants. They were also quick to note that, while co-working space seemed new to the region due to the rise of WeWork, this concept have been more prevalent in the western world much longer. While co-working spaces are getting more prevalent, they still occupy just 3% of the entire USA office space by NLA. They believe in Singapore is still less 5% right.

They would rather work with stronger, more established players. If a co-working tenant are willing to lease for 5 to 7 years, Manulife will consider exploring such opportunities (this is still a tad shorter than the typical 5 to 10 years of leases). Due to right sizing the days of large corporate offices might not be coming back.

One interesting thing is that the valuation of the property is affected by the tenant mix. And if you have more than 10% of your tenant base on these co-working tenants, that will be a penalty on valuation of the building. One main reason is that the leases of these co-working space tenants are rather short. In USA, some of these leases could be on a month by month basis (some3+3 months or 1 + 1 year).

The CFO explained that the valuation of a building is affected by general vacancy, and credit loss.

So if you have less established tenants with shorter credit history like the co-working space companies, this affects your valuation.

While a landlord like Manulife could charge them a higher rent, there are a fair bit of tenant incentives given for them to signed on as well, so that would negate the higher rental revenue.

Your CAP rate could go up but they are not going to stay with you for a longer time and secondly, you will be investing in more capital upfront to make the space look good for them, which will impact your cash flow in the early years, with much less cash flow in the latter years.

The Nature of Lease Agreements for Manulife US REIT’s Properties

Someone asked this question to the management: How come the government tenant at Penn is tied to a long lease, yet the lease do not come with any rental escalation?

I think the worry is, if inflation accelerates, the company will incur a large opportunity cost on a long rental lease. Secondly, when the debt is refinance to a higher interest rate, there are not much chance for the rent to be revised upwards. Manulife’s Penn might become a potentially unprofitable asset.

Penn has a WALE of 6.8 years and leased to United Nations Foundation, Department of Treasury mainly. The earliest expiry is 7% of the gross rental income in 2020. The passing rent is 12% lower than current market rent.

The management have this answer for Penn:If you have a government agency as a tenant, their credit is so high that the government agency do not have to pay rental escalation.

That comes across as very weird for me and I am not going to dispute that claim.

The CFO did provide more color to the nature of the lease. He explained that Penn is on a Gross Base Stop Lease. This means that a base level of expenses are identify, which is typically the annual expenses of the prior year. Manulife would pay that base year of expenses. For subsequent years, if the expenses rises with inflation above this base year expenses, these expenses would be recovered from the tenant.

In this way, if expenses go up with inflation, Manulife is protected. They will continue to earn that cap rate spread.

However, if the lease is long, they will still miss out on the opportunity cost and the cap rate on cost of property do not increase because there isn’t any rental escalation. They would have to depend on mid term rent review.

The CFO updated that almost all of Manulife US REIT’s properties have this cost recovery component:

  1. Triple Net Lease or Net Lease: Phipps, Peachtree, Figueroa

  2. Gross Base Stop Lease: Michelson, Penn

  3. Modified Gross Base Stop where Electricity and Utilities are fully recoverable while remaining expenses are base stop: Plaza, Exchange

Due to these recovery income, it makes Manulife’s portfolio NPI margin to be +-65% while the typical Singapore REIT’s NPI margin would be around 80%.

As you can see recoveries income is a fair bit. If we take this out, the revenue would be lower, closer to the net rental income. Thus the margins would be higher. It is probably how differently the US REITs and Singapore one account for things.

The Appeal of the Flow Through of Rental Escalation to Net Rental Income

The advantage that I see with so much cost recovery, as explained in the previous section is that all the rental escalation, and expense recovery will flow from the top line to the bottom line.

This creates some operating leverage, allowing the distributable income to grow.

However, I do have a concern how long WALE net lease will fair in a rising interest rate environment, versus shorter tenant lease properties.

And in my previous article, I did some sensitivity analysis what would happen in some realistically pessimistic rising interest environment.

I asked the management this question and the CFO replied that the nature of these cost recovery and rental escalation would alleviate that.

As the gross rent will grow by a fixed amount over time, but your debt is fixed.

When your debt is refinanced with a higher interest expense, your passing rental yield matches that interest expense because it has been escalating.

Now I am skeptical how that works.

More so for Penn. So I decide to do that simulation again.

Click to view larger table

In the table above, I showed a hypothetical property with a initial CAP Rate of 5%. We borrow 35% of the cost of the property with a 4 year interest only loan with an interest rate of 3.3%.

Due to the leverage, the income yield of the property is 6.68%. Like Penn, this property is on a Gross Base Stop Lease. All the expense above $400, is paid back by the tenant. So in the above illustration, you can see expense stayed constant at $400.

However, the revenue grow at 2.1% a year due to the inflation of expenses. The increase flows to the NPI. The management fee stays a constant $50.

You notice that the income yield rose from 6.68% to 7.67% in the fourth year, before plunging to 6.56%. The 4th year income yield is even lower than that of the first year.

The interest rate needs to be lower to 5.7% in order for the 4th year income yield to be better than year 0.

Thus, whether a long WALE property with leverage will work well in the rising interest environment would depend on

  1. the rate of change of interest rate

  2. the revenue growth

I realize that my revenue growth here is based on revenue. If this was to follow Penn, where the expenses are lower, the eventual revenue growth could be smaller.

Clarification on Rental Escalation of Manulife’s Portfolio

Manulife updated in their slides that their average rental escalation is 2.6%.

I checked with them that this 2.6% do not include the mid term escalation. Incidentally the good rental revision in Q3 2018, did include a mid term revision.

If they spread out the 2.6% across the entire portfolio, the average rental escalation per year is 2.0%.

Clarification on WALE of New Leases / Renewals and How they Calculate Rental Reversion

Some of the WALE is shorter leases (3 years), those normal leases are 5 to 6 years. The longest ones are 10 years.

Different REITs have different ways of computing their rental reversion.

In the case of Manulife US REIT, the rental reversion is the difference between the last/current year passing rent (after a few years of escalation) versus the new rent that was signed.

The Difference Between CBD and Suburban, Class A, Class B and Trophy Properties

I would like to get a sensing whether management would lean towards proposing property purchases in The CBD or in Suburban, but in all honesty, I do not have a good idea their difference from an investment point of view. How would an Class A office building in the suburban compare to a Class B office building in the CBD?

Turns out I do have a very poor view about their distinct difference.

CBD and suburban are just location for properties and cater to different type of work environment. The suburban concept is becoming more popular due to the work, play and live concept and it is something that Manulife US REIT is actively looking at. CBD would be closer to various amenities, and access to various headquarters of other industries.

In certain business context, sometimes it makes sense to be situate away from the city. Manulife shared with us how Michelson in Orange County is situated away from Downtown Los Angeles but Orange County is still very vibrant. The very rich and high net worth, have made their money, and as they get older, will gravitate away from the down town to settle in a place where they can both tend to their wealth, not be distracted and enjoy a balance of good living. They do not wish to visit Downtown Los Angeles every day.

Since they have a need to manage their money and interest, ancillary services such as wealth management, law firms would gravitate towards Orange County as well. Thus Michelson caters to these law firms and wealth management firms.

During the great financial crisis, Orange County was badly hit, as the wealth gets severely depleted and the office industry face a downturn. However, when the market recovered, the rich returned, the banks returned, the law firms returned, the demand for office space returned as well.

In terms of Class A versus Class B, they did educate me on some differences.

Common characteristics of Class A Office:

  • Glass facade

  • Floor to ceiling height must be decent

  • Windows must be big enough for light to come in

  • Quality in Lobby quality, air conditioning

  • Who the property manager

  • Generally bigger

This is how Class B Office differs from Class A:

  • Buildings generally smaller. About less than 6 stories

  • Floor to ceiling height is shorter

  • Less window spacing

If we try to relate to the local context, Class B would be closer to your business park compare to the MBFC. We cannot demolish the columns, ceiling and structure easily in an asset enhancement initiative to create a bigger floor plate to attract higher quality tenants.

Class A properties attract those who wish for it to be a headquarter that you wish to show it off to your clients.

Manulife states some reasons why they would steer clear of Class B properties and focus on Class A properties.

They think that the higher quality can be defensive. Class A properties attract tenants who wants prestige traditionally and Class B properties typically attracts the small medium size businesses.

Since they are an insurance company and does adequate underwriting, they tend to observe that during downturn, the Class A properties’s occupancy tends to fare better. In a downturn, both Class A and Class B rent trades down. However, the spread change in Class B rent is smaller, versus the Class A rent change.

Thus, when the rent spread between what you can get for a Class A rent and Class B rent narrows, a tenant would rather get a nicer looking Class A space.

Thus the occupancy of Class A is higher in a challenging climate versus Class B.

They would rather maintain that occupancy than to maintain a high rent.

Trophy properties are a sort of branding given to the best of the best. They tend to be newer (less than 10 years old compared to 25 years old average).

Given this, what kind of properties will they buy?

I think they have explained this a few times. What they will propose to the shareholders to purchase will depend on the price, the net property income yield that they can achieve and the quality.

Thus, we are priced out on a few markets such as Boston, New York, San Francisco.

Atlanta would be an area that they like.

What I am satisfied with is that if they are evaluating based on those three factors then things should not be too bad.

The following are the 1H 2018 Stabilized Cap Rates for various parts of CBD USA, segregated in terms of different property class:

The following are the 1H 2018 Stabilized Cap Rates for various parts of Suburban USA, segregated in terms of different property class:

Is Management able to Switch to a Quarterly Dividend Payout?

Management highlighted that non of the foreign REITs paid out quarterly.

It is certainly attractive and in my opinion it will be more popular to the shareholders.

However, management explained that the reason is that a quarterly dividend is not conducive in time and cost.

I will leave a lot of the details not said but if you look at the tax consideration in the rest of the article, they do factor as some of the things the management need to do, to get the cash flow back into Singapore. So a lot of the effort is spent getting foreign sourced income back, navigating through all the unit holder’s W8-Ben form status, the tax restrictions.

Once the money is back, the you have to navigate the reimbursement through CDP accounts.

The Impact of Impending Clarifications to the 2017 Tax Cuts and Jobs Act – Some thoughts about it

Manulife US REIT and Keppel KBS’s share price recently tumbled due to some uncertainty over whether their dividends are sustainable in light of some possible taxation changes.

Here is the chronological series of events:

  1. In Dec 2017, a new tax regulation called the Tax Cuts and Jobs Act (TCJA) was proposed in the Congress, approved by the House, Senate and the President and added to the Internal Revenue Code (IRC)

  2. As a reaction to #1, particularly 2 sections 163(J) and 267A, Manulife US REIT and Keppel KBS restructured their entire entity so that the impact on withholding tax that affect shareholder’s dividends is negligible

    1. To get around 163 (J), they restructured their sub-REITs in favour of the US parent REITs directly holding the physical property. If its a non property entity, there is a cap on the amount of business expense that can be used as a tax shield to a sum of interest income, plus 30% of its adjusted tax income, plus the taxpayer’s floor plan financing interest. However there is no such cap if it is a property company, hence the direct holding

    2. To get around 267A, they restructured by adding a Barbados intermediate company that lends the shareholder loans to the USA private REIT subsidiary. This circumvents the hybrid entity issue (more explanation later)

  3. In 22 Oct 2018, in Keppel KBS’s Westpark purchase rights issue official information statement (OIS), Keppel KBS warns that a TCJA clarification looks to be posted “imminently” and in the worse case scenario, may result in a 30% impact on income available for distribution. Manulife US REIT and Keppel KBS share price took a hit

  4. In 31 Oct 2018, Manulife US REIT issued more clarification on the possible impact to distributable income, the levers they could mitigate the impact. Share price stabilized

  5. Everyone awaits the TCJA tax clarification, which isn’t out yet

It seems a lot of the volatility in prices, is the result of the worse case impact of the TCJA tax clarification. This clarification, could be no impact, but also could result in both REITs needing to restructure their entire entity, incur costs along the way, and some drop in distributable income.

This tax clarification debacle can be pretty confusing, and due to the technicalities, it is hard to explain to a 5 year old boy.

However, in this week’s The Edge, Goola Warden explained it damn well in Yield watch in a piece titled: Taxing questions for US-based S-REITs as DPU yields expand. Goola met up with the management, particularly Manulife US REIT’s CFO Jag Obhan, who explained a lot of the technical side of things.

In particular, Jag explains 4 pillars that hold Manulife US REIT’s tax structure together to ensure that as much rental income flows through to the unit holders as possible.

Manulife US REIT’s current structure. Note the shareholder loan SPV and the Barbados Entities

1. The USA private REIT structure prevents corporate tax. As with Singapore, normal corporate companies need to pay corporate taxes. In USA it is 21% corporate taxes. If the USA entity is structured as a REIT, the entity can receive income without paying taxes and pay out cash flow without paying taxes. The criteria is that majority of the income is derived from physical property, and they pay out at least 90% of taxable income. Lastly, the entity must have no fewer than 5 person holding 50% of a company

2. Zero tax in Singapore foreign-sourced income. This was address in the previous article where Manulife US REIT have an agreement with Singapore IRAS to exempt foreign source income from taxes in the future, similar to other REITs

3. USA Portfolio Interest Exemption Rule (PIR). Normally, income that leaves the USA, is automatically charged 30% withholding taxes (like your stock purchases of Apple in NYSE). However, a group of shareholders with diverse nationalities in a Singapore company, for example, can lend a shareholder loan to a USA subsidiary ( in this case the private USA REIT ). THE USA subsidiary would need to pay the diverse group of shareholders an interest income on the debt loan to it.

This interest income, under certain conditions, is called a “portfolio interest” and its not subjected to the 30% withholding taxes. The conditions that will make it a portfolio interest is

  1. if you are one of the diverse shareholders, if you submit the W8-Ben form to prove that you are a non-USA citizen, your interest income would be exempted from withholding tax

  2. each of the shareholders must not be a 10% shareholder. A 10% shareholder is a company, partnership or individual that owns more than 10% in voting power of the company (in this case the USA subsidiary). This is why the parents, and the large backers, institutional investors in Manulife US REIT, cannot own more than 10% of the company

  3. you as one of the diverse shareholder, cannot be a CFC (controlled foreign corporation). A CFC is generally defined as any foreign corporation in which U.S. shareholders (each of whom owns 10% or more of the foreign corporation) own more than 50% of the USA subsidiary. Point #2 probably controlled whether any of the shareholders is a CFC

  4. you as one of the diverse shareholder, cannot be a bank

  5. you as one of the diverse shareholder,cannot be engaged in the conduct of a U.S. trade or business relating to the loan

Manulife have used this PIR for their cross border investments, their infrastructure funds and unit trusts. Other multi national corporations, funds have made use of this rule as well.

To their info, this PIR rule have been in existence for a long long time, and was not affected by the Tax Cuts and Jobs Act announced in Dec 2017.

4. Distribution from the US to Singapore through a hybrid entity in a combination of dividends, interest payments and repayments on shareholder loans. TCJA introduced section 267A, which disqualified “related party” tax deductions and distributions into a hybrid entity.

In the past, the use of hybrid entities with hybrid transactions are common in international tax planning strategies.

To put it simply:

  1. You are a Singapore parent and you have a USA subsidiary

  2. The Singapore parent loan the USA subsidiary a large sum of money

  3. The USA subsidiary take the loan to purchase the asset

  4. The asset generates an income to the USA subsidiary

  5. The USA subsidiary have to pay interest expense to the Singapore parent

  6. The interest expense reduces the tax payable for the USA subsidiary by reducing the taxable income.

  7. The interest expense therefore a form of tax deduction, a tax shield because it reduces the amount of taxes the entity pays

Under Section 267A, hybrid transactions made to and from hybrid entities no longer are qualified for tax deductions.

In the lawyer speak: deductions would be disallowed if certain “disqualified related party amounts” paid or accrued to a related party were made pursuant to a hybrid transaction or made by or to a hybrid entity.

So what can be considered disqualified related party amount? It can be considered one if:

  1. the amount is not taxed under the local tax laws of the country in which the related party is a resident for tax purpose or the related party is subjected to tax. So in our example, if the interest income from the USA subsidiary is not taxed when it gets into Singapore, then its considered disqualified related party amount

  2. the related party is allowed a deduction with respect to the payment under local tax law. In the example it means it claims interest expense deduction at the Singapore parent level

Under the old structure for KBS and Manulife US REIT (Before Dec 2017), they would have violated #1.

Thus, both of them restructured by including a Barbados based structure.

Jag said the following in the Edge article: “We had implemented a Barbados structure, which addressed two issues. One, the entity in Barbados was treated as fiscally transparent in Barbados and the US, and two, we pay some tax in Barbados. We selected Barbados because Manulife already has a presence there and we like to go to tax regimes we have experience with. Whenever we select our tax regimes, there are three to four criteria. First, it has to be politically stable. Second Manulife has to have experience or a presence there. Third it has to comply with the tax rules. Four we try to assess where there is the least tax leakage and whether it is beneficial to shareholders”

Barbados have withholding tax but it is very low:

  • 2.5% on income received up to US$5 mil

  • 2% between US$5 mil to US$10 mil

  • 1.5% betweenUS$10 mil to US$15 mil

  • 0.25% for greater than US$15 mil

Then when the income is send back fro Barbados to Singapore there is no withholding tax payable.

Under this structure, Manulife US REIT is not considered a hybrid security under US tax laws as the interest income from the shareholder loans is taxed in Barbados, and does not claim deductions.

It should be emphasize that this structure has been put in place by Manulife US REIT and Keppel KBS one or two days after the Tax Act announcement in Dec 2017.

Visualizing the 4 pillars with a Waterfall

Perhaps here is an illustration of how these tax shield work from Manulife’s point of view. The properties are held in a holding US private REIT company. Suppose this USA entity earns a gross revenue income of $100.

Out of the $100, they have to pay $20 in mortgage interest expense for the property portfolio’s onshore mortgages, which is mandatory.

So you have a net rental income of $80.

For tax purpose, the tax authorities recognize depreciation of the properties, over a particular lifetime. In the USA the properties are usually depreciated over 40 years, which comes up to approximately 2.5%. So for a portfolio with asset cost of $1700 divide by 40 years, the depreciation would be about $40. This depreciation is not a cash outflow.

What is left, you could shield it with interest expense of $40 dollar.

You end up with 0 taxable income and thus you do not pay a 30% withholding tax on $0.

Manulife US REIT and Keppel KBS current structure meets this requirement, hence it is tax efficient.

Should the USA entity be considered an hybrid entity, and interest expense is not deductible, it won’t be the $80 net rental income that is subjected to the 30% tax.

50% of it is protected by depreciation. Since only 50% is affected, the maximum tax that could be levied is 0.5 x 30% = 15%.

So you could see that if depreciation is done more aggressively the EBIT could be minimized to $20-$30. Instead of a $12 tax it might become a $6-$9 tax.

Clarifications do not mean a change in Tax Code

Usually, these sections and codes in the Internal Revenue Code can be vague and organizations would have questions and will keep asking the IRAS.

So IRAS would pay attention to the feedback, and then provide clarifications to the tax act that was announced.

So these clarifications would typically provide more color to what can qualify and disqualify for various sections.

What scared the markets was that Keppel KBS said the clarifications would be out “imminently” and in the worse case scenario the income available for distribution to be down by 30%.

Manulife’s Statement on the Potential Impact after the TCJA Clarifications

Manulife US REIT gave a clearer guidance about the extend of the impact, while Keppel KBS remained quite all these while.

  1. Maximum 15% downside risk to distributable income from the new tax legislation. This is due to the existing tax shield from depreciation. If their structure is deemed a hybrid and they cannot leverage on the tax shield from interest income and would face a higher tax

  2. There are ways to reduce the 15% even further such as increasing the depreciation rate via accelerated depreciation

  3. They could also switch to alternative jurisdictions if Barbados became not viable

Analyst’s Opinion on the Tax Issues

Deutsche Bank thinks that the clarifications would clarify what tax deductions are allowed under Sec. 163(J) and what are disallowed under Sec 267A. Thus it is a clarification of which is which and this should not affect the current shareholder loan deduction.

DBS however, highlights some areas where the tax authorities might find fault:

  1. They might decide that Barbados entities are not partnerships under the US tax code

  2. The tax paid in Barbados is too low

  3. The tax authorities looked at Manulife US REIT’s structure in entirety or on a look through basis and focus on the Singapore SPV

Moving Away from Barbados, if it gets disqualified

Manulife and Keppel KBS both satisfied this new TCJA. However, they might view that some of these local taxes paid to be too low. That would mean some form of discrimination, and perhaps setting a minimum percentage amount of local taxes to not be deemed a disqualified related party.

What is the likelihood? I am not sure.

To satisfy this, Manulife could choose another country with low tax, but not so low tax as Barbados. Then it will still qualify of interest tax deduction.

The Barbados structure puts just 1.25% of distributions at risk (50% of 2.5%)

If they pay the corporate tax in Singapore (mentioned in the Edge article) the risk to distributions is 8.5% (50% of 17%)

They could also choose a location with a tax rate somewhere in between. One example could be Hungary with 9% corporate tax, which will put 4.5% of the distributions at risk.

Assuming the dividend per unit to be US$0.06 and share price to be US$0.77.

If we restored the 1.25%, the DPU would be $0.06076.

A 8.5% shaved on DPU would make the DPU to be $0.0556. the dividend yield will be 7.22%.

A 4.5% shaved on DPU would make the DPU to be $0.0580. the dividend yield will be 7.53%.

What do I think of this tax situation?

The impact of the tax clarification would possibly centered on the outcome of Section 267A.

If we reviewed the 4 pillars that Manulife talked about, #1 to #3 should be Ok.

The PIR is widely used and have been around for the longest time. It is unlikely to change.

If you change that, a lot of funds, in the wealth management side in that country will be affected. USA would likely still wish for foreigners to invest in their country, indirectly through the wealth management industry, to at least put the US dollar in demand.

Thus, if both stocks maintain a less than maximum 10% each shareholding structure, this would be taken care of.

Prior to 2017 Dec, the last change to the Tax Code of IRS was in 1986. The recent TCJA was proposed in 2013, discussed and passed recently. It took 31 years to change the tax code, which suggest that it is not so easy to change the tax code.

By all research, the issue with the section 267A is that what is considered as a hybrid entity is not very clear. And thus further clarifications is required.It could be some countries such as Barbados are listed as countries that cannot be used for tax deductions. I think this would be very grey as where do you draw the line? How low of a country’s corporate tax would have to be to fall within the list?

Manulife US REIT could change the jurisdiction and accelerate the deprecation.

I have illustrate how moving to Singapore or Hungary, and the impact to dividend yield. You would have to think, what does the market value this property, with its management, versus the risk free rate, and its competition.

I think that the likely impact to the DPU is within 10%. If not there is no impact.

However, given any reduction in distributable income, I felt the share prices would be negatively impacted, regardless whether these risks are already out in the open.

I cannot help but think that, if this tax structure is badly affected, the upcoming REITS by Ascendas Singbridge, and another Grade A property REIT from Keppel KBS would be hard to list.

Manulife US REIT’s Capital Strategy – Unencumbered Assets, Perpetuals and Convertible Bond Issue

One of the investor referred the management to the capital management adopted. He questioned that if Manulife’s portfolio of office is indeed made up of Grade A and Trophy properties, why does the banks still need them to collateralize the properties to the debt?

He compared and contrast to the operating environment for local operators such as Capitaland.

Jag, the CFO, explained that this was some sort of restriction on the REIT due to a rule called the Thin Cap Rule.

The Thin Cap Rule in the USA REIT environment aims to prevent a lot of shell companies that are “thinly capitalized” from cycling money out of USA. If the company have too much leverage, then it is not a real company.

If you take a loan on an unsecured level, then this would violate Thin Cap Rule.

Thus, the debt is asset backed.

A lot of established countries have their version of thin cap rules.

Now after the Dec 2017 TAJC, the Thin Cap Rule does not exist.

This means that the management can consider other forms of capital debt.

It sort of explained the confusion why they said that their strategy is to have unencumbered properties yet their properties are utilized.

If you have assets that have not been used to secure loans, it gives your REIT that flexibility during credit crunch to propose this to increase your chance to secure a reasonable loan.

The management highlighted that going forward they wish to:

  1. increase their financial flexibility

  2. make themselves cost neutral versus the secured financing

  3. increase debt headroom

One of the investor propose, why not turned to convertible loans, since the cost of interest would be low, which might work well for them.

The management have some thoughts about why they do not implement convertible

  1. It introduced a new level of complexity, something unit holders might not understand. And when they do not understand they become less receptive over it

  2. It does not help their leverage ratio

  3. If they are talking about cost of debt, they believe that through medium term notes (MTN) and bank loans they can manage their debt cost just as well

Manage are comfortable with 5% to 10% of their capital base to be made up of perpetuals (you can read more about perpetuals in this article of mine here). Perpetual is considered an equity, higher seniority than equity, but is a form of debt.

Rating agency would consider 30-50% of perpetuals as debt instead of equity but Manulife US REIT sees them as a cheaper form of debt. This is so in those kind of times when their equity prices is low, and the cost of equity is high, relative to perpetual.

This would enable the REIT to still be able to acquire.

So Manulife would like to be opportunistic in being able to use perpetual to acquire.

Manulife US REIT’s Capital Strategy – Trading Liquidity, AUM Size, Rights Issue, Preferential Offering, Placements

I think management tried to solicit some views regarding as investors, what is our preference for equity raising.

They also explained their past approach in their acquisitions of Plaza, Exchange and Penn + Phipps:

  1. Plaza – Private Placement 3.5% discount to VWAP. Placement at US$0.83 (oversubscribed)

  2. Exchange – Renounceable Rights issue 28% discount to VWAP US$0.96. Rights at US$0.695 to raise US$208 mil

  3. Penn + Phipps – Non-Renounceable Rights issue 7.9% discount to VWAP. Rights at US$0.86

The first few issues was to increase the liquidity of the REIT. If the liquidity is not increased, then it would be difficult for high net worth investors to exit if they required.

This is a strong consideration for the larger, institutional investors.

Even if Manulife US REIT reaches a hypothetical 10% yield, the institutional investors would be difficult to invest because they would jack up the share price by themselves, and if they exist, they would bring down the share price themselves.

The management is aware that there are institutional investors observing on the side lines to see how they operate the REIT, before being invested.

Once you are able to get a few more of these larger investors in, your REIT will have a little more stability.

So the first placement was to address this.

As the liquidity picks up, it also make it easier for institutional investors to get invested.

When the REIT grow bigger, it is easier for placement to happen. The discount offered is also lower and thus this makes acquisitions easier.

While it might be a stretch to make an accretive acquisition of a 4-5% cap rate property in Washington, if the cap rate is closer to the dividend yield, a slightly discounted placement can make it accretive, and this can allow the REIT to increase the AUM. (which is what will motivate the management)

Once that is done, then they cater to the retail investors.

The retail investors have constantly feedback to let them participate in any deals that the REIT has.

The 2 investor that gave their views prefers that placements and preferential offering be done. This is because for rights issue, you have to set aside some of your money to be ready for the rights issue, which is not preferable.

Preferential offering is preferred because the discount is smaller, yet it allows the unit holder to participate, should there be a need to.

Shortly after the meeting, I send in my views.

It goes along with something like this:

I have this weird view that the REIT should do the capital allocations that in the long term, they could raise money in a more sustainable manner. So for most REITs, there is a maximum that they can leverage. A more sustainable way is to ensure that the REIT have a lower cost of equity.

To have a lower cost of equity, that means the share price needs to be strong.

For the share price to be strong, it needs to be well supported, and the people that can fund future deals better are the institutional investors. That probably answers the question which financing way is preferred because the institutional most of the time prefer the REIT not to do a rights issue as it create more problem for them.

If the institutional are looking for adequate liquidity (as you have explained to us), management that does all the right things, quality assets, strong rising DPU trend, and a track record of making all the right decisions, then they would continue to support because they get a good total return, for the risk, the effort that they put into.

As retail investors, aside from speculative special situations, most of the time we prefer to invest in a REIT that we know the management had our backs. The rights issue discount is very appealing to us, the retail investors, but honestly if we look at past heavily discounted rights issues, not many have worked out that well in the long run (meaning the share price became strong and return to where they were). The odd exception was First REIT, or the Ascendas, Capitamall in the past.

So my preference is for the REIT to take care of those who are going to give the REIT the large capital to fund future acquisitions, which often entails institutional investors, make the returns and performance strong. The retail investors will join in for the ride.


I started this article by highlighting some qualitative reasons why Manulife US REIT share price is not doing well

  1. Rising interest rate environment generally challenging for REITs

  2. Volatile stock markets these few months

  3. Fundamental uncertainty due to possible reduction in distributable income

And you could add the uncertainty of Michelson’s rental expiry into the mix.

When there is uncertainty, there is risk, and when there is risk, you hope that there is a high compensation.

And thus it explains why Manulife US REIT is trading closer to 8%.

I think within 40 days, we might see the tax clarification and that uncertainty cleared up. Before this, you have to perhaps factor in the impact to the dividend yield. The dividend yield might be closer to 7.2% to 7.5%, instead of 7.9%.

If you look at this, versus the historical dividend yield, for a long time before the rights issue, the dividend yield trades below 7%. Thus even this looks attractive.

But we cannot look at the dividend yield versus historical on its own.

The interest rate environment is rather different now in that interest rates have rose quite a bit.

We typically value REITs by comparing its dividend yield minus the 10 year government bond yield, then compare to the historical.

Since Manulife US REIT is a USA REIT, here is the trend for 10 year Treasury taken from Investing.com:

Since the start of the year, the 10 year have gain like 90 basis points (or 0.90%).

I have provided 3 dividend yield of 7.9%, 7.5% and 7.2%, depend on how the tax clarification would turned out.

So the respective yield spread would be:

  1. 7.9%: 4.86%

  2. 7.5%: 4.45%

  3. 7.2%: 4.15%

Here is the historical Singapore Dividend Yield and the historical Dividend Yield Spread over 10 year Government bonds.

If we compare the equivalence to dividend yield relative to 10 year SGS bond yield, Manulife US REIT’s spread is greater than the +1 standard deviation of the historical yield spread. If we talk about its dividend yield versus the average of the Singapore REITs going forward, it is also much higher (however, I think it is not very right to compare just the average dividend yield, since different nature of REIT command different average yields)

A more proper measure would be to compare to the US REIT’s yield spread.

The only ones that I can get is some data published by Lazard Real Estate, whose data is rather new. However, I realize this is not a yield spread comparison. It does make interesting data because we are able to see just how narrow the spread of Baa bonds interest rate to the CAP rate of properties.

At current the spread is just 1.5%. The value point is when some of the spread reaches 4%.

It should be noted that the bond rates that they would borrow at was typically at 6 – 8% (!). Manulife US REIT’s last fixed cost borrowing is closer to 4.4%. This is probably an area of discussion next time, if I have a question to ask.

In the bottom section, we can see the historical price to funds from operations for the REIT market. The long term average is 16.5 times.

While we do not compute funds from operations locally, something close to be an adjusted funds from operations (AFFO) which is FFO – capex, is our income available for distribution.

Generally speaking AFFO should be lower than FFO, so it means equivalently, Price to AFFO should be higher on the average.

So we talked about 3 DPU during this discussion, the corresponding price to income available for distribution is:

  1. US$0.06: 12.8 times

  2. US$0.0556: 13.8 times

  3. US$0.058: 13.2 times

The valuation, whether taking a more conservative DPU or optimistic one is much lower than the average price to FFO. And its not even a fair comparison. If we were to use Manulife US REIT’s FFO, the price to FFO likely would be slightly lower.

As of Aug. 31, 2018. Source: S&P Global Market Intelligence

If we break down by segments.

I think in perhaps 1.5 months we will know whether there are material impact due to the tax clarifications.

Perhaps in 3.5 months we will know whether there is rental impact if major tenants at Michelson does not decide to stay on.

The rest of my REITs stuff, probably can be found in Learning about REITs below.

Do let you know what you think of this.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often.

Here are My Topical Resources on:

  1. Building Your Wealth Foundation– You know this baseline, your long term wealth should be pretty well managed

  2. Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience

  3. Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors

  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG

  5. Free Stock Portfolio Tracking Google Sheets that many love

  6. Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free

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thanks for ur effort in sharing bro. as always, good info!


thank you for the sharing this extensive insight.

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Thoughts on Manulife US REIT’s Accretive Acquisition of Centerpointe I & II
- Original Post from Investment Moats

Manulife US REIT (MUST) recently announced their 8th Grade A Office acquisition and their first quarter 2019 results.

This real estate investment trust (REIT) is a REIT I covered a lot on this blog, thus I do not wish to go into detail on it. You can take a look at the list of past articles I wrote about MUST to frame your decision.

This article is to provide you what I know about the acquisition and my perspective about it. (I wanted to say something about the first quarter results but probably another day. If not this will be too long)

The Acquisition of Centerpointe I and II

Based on the way the management structured the slides, and how the share price of MUST have performed during this period, you have the feeling this is coming. So this acquisition is not a surprised.

Centerpointe I and II is a sub-urban Grade A office in Fairfax county in Virginia state. The purchase consideration is US$122 mil. I do see this purchase as pretty similar to theSecaucus Office Tower purchase in 2017 for US$115 mil.

The Secaucus Tower purchase is also situated in a sub-urban setting. These two purchase aligns with MUST’s strategy of playing into the Live, Work, Play theme.

One thing you realize is that a lot of the office building in the portfolio is around entertainment places. At the door step of Centerpointe I and II is the Fair Oaks Mall. Management was asked in the past whether it would be better to be situated around other offices or amenities such as these and the answer is they prefer the latter. This is because the tenants finds it attractive to be in an office where it is convenient for the workers so that the workers can be more happy working there. In a lot of the correspondence, comparisons versus nearby competition centers on occupancy, rents and also what the competitors have, or do not have, in terms of these amenities (but I think compare to Singapore malls there is a world of difference).

The management believes there is an emerging demand for office spaces that are closer to where people lived. In some of these places, new housing projects will be developed and we will see increase in population due to the good demand of good paid work.

This quite aligns with one of my main criterion for determining if a REIT is good to buy and hold. You would rather hold a property, or a portfolio of properties that the future growth outlook is good, or less problematic.

So this could be an area where

  1. they are emerging from problems

  2. areas where the demand dynamics has always been strong and there are evidence that it will continue to remain strong

  3. not declining demand and supply dynamics, falling industrial production, businesses leaving

Centerpointe I and II purchase fits somewhere between #1 and #2.

Fairfax is very close to Washington D.C, where MUST have another office building there in Penn. Management thinks that the business dynamics of this area is dominated by

  1. Technology companies

  2. Healthcare companies

  3. Government contractors due to how close it is to Washington D.C

Due to its proximity to the capital of the country, there are many business headquarters situated in the capital.

The nearby suburban towns are home to the highly paid people that support these businesses, who needs to be close to the capital. The median income of the area is in six figures. 63% of the population have Bachelor degrees.

Of the 10 richest county in US, 5 are in Virginia state.

So basically the idea is that the capital will remain in Washington, there are a set of businesses that has to be close to the capital. Due to the cost in Washington, as well as the available space, those business that needs to be close by would need to situate in areas that are closer enough, accessible by good transportation links.

With Amazon HQ2 being in Arlington, Virginia, we might start seeing more companies that will take Amazon’s lead to situate in Virginia.

What I didn’t think about is the significance of Amazon HQ is that they are like a technology capital on their own. They will attract a set of ancillary services, be it tech, law or in other forms, to be situated close to it.

I believe cities/area has a lot of network effects.

If there are good job growth, people will flock to it. So areas where there are vibrant business, good jobs, they will attract people, and this feeds into itself.

One thing that you may ask is, is there a difference between an office in CBD and an office in sub-urban. I think it is more of a location thing. It is like comparing an office building in Raffles Place versus one in Tampines. Tampines is more closer to where you live while Raffles is where majority of the MNC and financial institutions have their headquarters. Within Tampines, you have higher grade buildings versus those that are lower grade. Hence, what MUST chose to own are the Grade A Office buildings in the sub-urban areas. Ultimately, what drives whether that is a good asset are the grade, because higher grade can be defensive in terms of occupancy, but also the direction and development of Tampines.

I explained more of the difference between Grade A, Trophy and Grade B in this post here.

The Financial Numbers behind the Acquisition

The market capitalization of MUST is around US$1.1 bil and this acquisition is about 10% of it.

Here are some of the stuff that I am focused on:

  1. Grade A property. Tallest in the region. It is basically what you see when you enter Fairfax by highway. Opportunity for Signage.

  2. 98% occupancy. On average occupancy in the past is 94%.

  3. WALE of 6.9 years. 70% of them expires 2024 and beyond. 4.5% expiring in 2020. 13% expiring in 2021

  4. 100% of leases built in escalations of 2.5% to 3.0%

  5. Rental rates is 10-25% premium above market rent over the last 8 years.

  6. Tenants Board of Supervisors for Fairfax County, Edelman Financial Services, ASM Research have been there since 2011

  7. Majority of the tenants there tend to use the building as their headquarters

  8. Passing rent of $33 sqft/mth versus Asking rent of $34 sqft/mth

  9. Implied CAP Rate of 7.55%

  10. Very limited construction in the area. The acquisition cost prices the property at around US$300 psf. The replacement cost, if they were to construct a new one is closer to US$500-550 psf.

I think the quality of the property does not come in just the building the location, but also the length of the leases and the financial standing of the tenants. In this acquisition, they looked to tick the right box. Nowadays, I felt a lot of the value of the property lies in the quality of the leases.

They have the government of the county headquartered in their building, ASM Research is also a high revenue subsidiary of Accenture for sometime. Listen to enough financial planning podcast and you would know Edelman financial is a big player in the space. (You can google up Ric Edelman and his theory of us living longer and how it changes retirement and wealth management)

What this does to MUST’s portfolio and for the shareholders is:

  1. Diversify away from Legal and more into Information Technology and Public Administration

  2. DPU accretive to existing shareholders. Management illustrated a 3.3% growth in DPU

  3. Diversify away the tenant risk

  4. Reduce the gearing with the placement, increases the debt headroom

  5. Increase free float to US$1.1 bil, closer to the US$1.2 bil target for Index Inclusions

When I look at the figures, the net property income yield is abnormally high for a MUST property.

If we look at the Net property income and the price MUST purchased at, this gives an NPI yield of 8.88%! Then why is the implied CAP Rate at 7.55%. One thing that you have to understand is that based on the purchase price and the income we are getting now the cash flow yield is 8.88%. However, the implied CAP Rate factors in some capital expenditure that MUST is looking to do over the next few years (from what I understand it will be around US$6 mil)

The implied CAP Rate (which is NPI/(market cap + debt)) likely factors in a different property value than the purchase price.

Implied CAP Rate = NPI/Property Value

Property Value is equal to the discounted cash flow of the future cash flow that we get from Centerpointe, calculated as below:

For some of the early CF, the Cash Outflow is more due to capital expenditures carried out. So net net, the CF1 and CF2 is lower. Since based the CF early on has a higher weightage, the property value, based on DCF would be relatively lower.

When we eliminate these cash outflow, the future property value, should be higher. So the implied CAP Rate seemed to be based on this.

It should also be noted that net property income might contain some straight-lining. The actual cash flow from Centerpointe might be lower or higher than the net property income depending on each of the leases for the tenants.

For the TL:DR version:

  1. the net property income should not differ from what the management guided since this affects the denominator (property value)

  2. the property value should be higher in the future

  3. this should not affect the DPU guidance.

Still an Implied CAP Rate of 7.55% is very high.

CBRE Office Cap Rate Survey 2H 2018

If I am right that this belongs to the Washington, D.C Sub-Urban market, the yield is quite high.

Acquisition by Placement

MUST eventually acquire Centerpointe by:

  1. Getting US$94 mil in equity issue by placement to new institution investors and existing ones. 114 mil new shares were issued at a placement price of US$0.824. This is a 6.3% discount to the closing price of US$0.88.

  2. Probably US$28 mil in debt at assumed interest rate of 4.1% for 5-yr USD loans

The eventual placement was around the mid point of the price range they decide to place out at. Still, it is a 6.3% discount compare to last traded price. I am no expert at this. Do let me know in the comment if you think this is too big of a discount. From what I understand, the placement was closed in 1 hour and well over-subscribed.

I think through numerous feedback sessions, management have a sensing from various groups how they should do future capital raising.

I think this is the way to go for a few short reasons:

  1. Purchase properties that looked attractive and high quality to shareholders

  2. The speed of the execution. Compared to rights issue which will take some time

  3. Rights issue usually needs a bigger discount, and it sort of signals to the public that you do not have the power to do non-renounce-able rights issue, placement at slight discount due to the weak share price. It tends to create a lot of unwanted share price volatility for existing shareholders

  4. It secures the money fast so that you do not missed out on the deal

I will probably elaborate on #4 later.

I do get some comments from the REIT telegram group that usually a placement discount is not DPU accretive. I do find it strange why it cannot be accretive. I thought in most cases it should be.

So I decide to put in the computation in my calculator:

For those who have never seen this table, I usually break the rights issue / placement into 3 areas:

  1. The state of the stock before the rights issue / placement before capital raising

  2. The asset that they are buying

  3. The state of the stock afterthe rights issue / placement before capital raising

I used a share price of US$0.88 which is what MUST closed at. We raised 94 mil in equity and 28 mil in new debt.

I have used US$8.9 mil as the increase in distributable income projected by the management (note: it is not the 10 mil NPI because you need to factor in management fee due to the increase in AUM and about 4.1% in debt cost on roughly 28 mil).

So what we get is:

  1. DPU rise from 6.04 cents to 6.18 cents. A change of 2.4% versus the management projection of 3.3%

  2. Dividend Yield rise from 6.86% to 7.03%

  3. Debt to Asset fall from 37.35% to 36.43%

This acquisition looks pretty alright. Seems to be accretive to me.

I think this moves the REIT closer to a goal of the management, which is to get included in a regional index. With the inclusion, it will give funds who wish to mirror the index, reasons to add MUST into their holdings.

Some of the criteria for that to happen:

  1. You need an English Annual Report (checked)

  2. Real estate predominately in developed markets (checked)

  3. Free Float of at least US$1.2 bil (not checked)

With this acquisition, it means that they are closer to the $1.2 bil target.

I think if they get to that state and stay there, this might be good to shareholders. But personally I think that you may get a share price boost but if your share price gets wack, and you have to be excluded from the index, you get wack even harder.

Some History of Centerpointe I and II (and whether there are opportunities of growth)

Centerpointe I and II was built like 30 years ago. Since 2007 to 2011, Thomas properties group andCalifornia State Teachers’ Retirement System (“CalSTRS”) owned the 2 buildings.

That was probably at the height of the property and economic downturn in the country. In the article above, it stated that a large block of space could become available in late 2007.

I think they were expecting it to turned out well. But due to the economic downturn they could not leased it out.

In 2009, as per Thomas Properties Group report, only 54% of the property is leased. The annualized net rent per leased square foot is US$18.31 and the annualized net rent is US$4 mil. If we assumed 100% occupancy the net rent per leased square foot is US$34/mth (this seemed to be the asking rent now). The annualized net rent at US$7.4 mil looks lower.

In 2011, both Thomas Properties Group and CALSTRS sold to a JV led by Carr Properties Group for US$128 mil or $307 psf. The building at the acquisition is 92% leased, and the average asking rent, according to CoStar’s information is US$34 psf/mth (again similar to the asking rent now).

So basically, MUST bought the property at a cheaper price then the consortium bought in 2011. Does that mean that for shareholders, they won’t see growth in asking rent ? If there are rental escalations of 2.5-3%, then how come the asking rent remains at US$34 psf/mth.

What I gathered is that back in 2011, the idea of the purchase is a prospect that there will be increase government contracting outsourcing work and thus there are more office demand spillage over to Fairfax. However, government decide to reduce the government spending instead, and this affected the growth story that Carr Properties originally envision. This is probably a caveat for investors how demand and direction of rent could change so much due to changes in government policies.

I am not sure. I can only show you the history so that you are aware about things.

Jennifer, the CIO of MUST have been scouring for potential good acquisitions all this time and over the past 24 months, they do see a picking up in leasing activities.

This deal was presented on the auction market and it may be due to Carr Properties Group change in direction.

Carr Properties, is a leading developer and owner of properties in Washington, DC market. Their idea is to own properties in “Forever” market. Their idea is to own high quality, irreplaceable portfolio with a sound balance sheet. Carr is a partnership made up of Oliver Carr (2.5%), JP Morgan Asset Management (34.8%), CLAL Insurance (13.7%), major Isreal Insurance company, ALony Hetz (43.7%), Isreal’s largest commercial real estate holding companies.

From what I understand, one of the partners, who I guess is Oliver Carr wishes to focus on the Boston area where there are more development opportunities. This might be a reason to wind up the partnership.

If we look at Carr Properties’ slide deck, we can have a good idea what are the kind of properties that they choose to purchase and keep. And a lot of their philosophy are pretty close to what was communicated by MUST.

So now it will be the shareholders turn to see if the property value appreciation comes to Centerpointe after the previous two owners didn’t get a lot out of it (other than rental cash flow).

Personally, I like to think that this is management, taking a punt based on their expertise, that this deal from the public market is undervalued, with a potential to grow. It sort of challenge the commonly held narrative that majority of their acquisitions will come from parent Manulife US Real Estate.

With strong share price, capital raising through private placements allow MUST to make swift purchases if there is an attractive deal on the market.


I think MUST is one property acquisition away from a healthy float that would enable a inclusion into an index.

There is a main advantage to that. I think a re-rating would give them a lower dividend yield, which makes cost of equity cheaper. There will be more assets that fit the criteria on the market.

More so, there can be more assets that have the potential to yield more than 7%, but currently do not. These cannot be purchase currently due to the prevailing dividend yield, which will make the acquisition not accretive.

I do think however, the real re-rating will occur if investors start recognizing the portfolio has a long lease, good quality assets, increasing DPU and provides a less volatile cash flow.

When investors recognize this profile, the fair value dividend yield can be much lower, and as shareholders, you will benefit from the yield compression. This is what we are seeing for PLife and Keppel DC for example.

This would take time, and for deals like Centerpointe to show the investors whether the management can really pick out gems in the market. If these acquisitions do not turned out as well, more questions are asked, more uncertainty, and the fair value dividend yield would be where it is now, or even higher.

The market is rather brutal this way.

Here are my past write-ups on the company.

I write more on REITs. You can read them in the Learning about REITs below:

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often. You can also choose to subscribe to my content via email below.

Here are My Topical Resources on:

  1. Building Your Wealth Foundation– You know this baseline, your long term wealth should be pretty well managed

  2. Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience

  3. Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors

  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG

  5. Free Stock Portfolio Tracking Google Sheets that many love

  6. Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free

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More High Yield Certainty from Manulife US REIT FY 2018 Result
- Original Post from Investment Moats

Manulife US REIT last week announced their full year 2018 results. $ManulifeReit USD(BTOU.SI)

I was able to have the opportunity to listen in on the earnings results during a brief for the media.

For the investors interested in this sector, this is not the first time I wrote about it. To understand the REIT more, you can read some of my in-depth articles on the REIT:

My friend B from Forever Financial Freedom have wrote his experience at the Full Year results brief. I think he covered most of the points of discussion from the meeting.

I am not sure if I am slow to this, but I was informed that they have also put up Webcast on their results brief on their Investor Relations page. I think the analyst raised some good questions and it might be beneficial for you to check it out if you are a longer term investor.

I think what I will do is to cover some points that might not have been discussed in the 4 articles above, or relate to this quarter’s results.

Increase in Dividend per Unit

The portfolio performance for this quarter is good. Gross revenue rose 38%, Net property income rose 38% and distributable income rose 33.8%.

Much of the great growth was attributed to the full year contribution of Exchange, Penn and Phipps. Due to rights issue and preferential offering, the REIT’s outstanding share base have increased. As such the distributable income would be less meaningful.

Hence the manager presented an Adjusted DPU which show how the DPU would look like, if we had full contribution from all assets, and factor in the enlarged asset base.

We can see the adjusted DPU for each of the quarters below:

  1. Q1: 1.51 cents

  2. Q2: 1.53 cents

  3. Q3: 1.52 cents

  4. Q4: 1.54 cents

That is a total of 6.1 cents. At a share price of US$0.84, this gives a dividend yield of 7.26%. (at the time of writing, the REIT should have gone Ex Dividend. The share price before Ex Dividend was at US$0.87)

This is always a problem with REITs that does a lot of these equity financing. It becomes a challenge to figure out what is the dividend yield. Some months ago, I got into a discussion and was told using these adjusted figure is “not conservative”.

I mean, yes it might not be conservative and I could possibly throw a random DPU of 5 cents. However, would that help yourself if realistically you know the forward DPU is closer to 6 cents, yet we use a historical conservative figure? You could possibly use 5 cents if you are trying to find that margin of safety. If at 5 cents DPU, Manulife yields 7% (which it did at one point not so long ago) then this is attractive!

If I put out a figure on my Dividend Stock Tracker, I have some limitations. I cannot cater to everyone. So I try to the best of my ability to put a figure that I think, going forward it is realistic.

I think back to the DPU, we could have annualized and project going forward, next year’s DPU to be 6.16 cents. However, judging by this up and down per quarter trend, take it as 6 cents or 6.04 cents might be more conservative.

Hyundai’s Lease Renewal at Michelson

In my past articles, we raised that there are possibly 3 uncertainties that affect the REIT’s share price:

  1. Rising interest rate

  2. Potentially much higher taxes that cuts into dividend due to changes in the 2017 Tax Cuts and Jobs Act

  3. 30% of Michelson will be up for renewal in 2019

#1 eased off globally these past months and #2 became clearer by end Dec 2018, which should not be of material impact to the REIT. (while #2 seems like a non-event right now, you should read my third and fourth articles in the links above for more colour how some risks you thought its small might potentially become very material)

So that leaves us with the 30% expiring lease at Michelson.

For a relatively new REIT, we have no idea whether they are able to manage this aspect well. 30% of a building is potentially high impact. So that is why I listed this as an uncertainty.

We got hints during the last results brief that there was good news. And the manager certainly didn’t disappoint.

Hyundai renewed their space for 11 years. There is a built in 3%/yr annual rental escalation.

This is not reflected in the WALE, which stayed at 5.8 years, because this new lease would only be reflected in FY2019. Per KGI report, Michelson’s WALE will jump from 3.4 years to 5.4 years due to this renewal.

Actual rents were not disclosed, but management have indicated that current passing rents, due to the annual rental escalations, have outrun the market rent.

So we do expect that the rent revenue from Michelson to be lower.

We do not know the extent of the negative rental reversion but you could use a few figures and do a sensitivity analysis.

Renewing the Hyundai lease would reduce 2019’s expiry from 10% of Gross rental income, to 5.5%. So the impact to gross income is 4.6%.

Assuming it’s a -10% negative reversion, this would be a 4.6% x 0.10 = 0.46% impact to the REIT’s top line.

With an average overall portfolio rental escalation (annual rent revision + mid-term rent review) of 2.1%/yr, next year’s gross income growth should cover this.

If we look at it another way, in 3.5 years, the rental escalation will result in the passing rent to be where it is now. What the REIT get is they do not need to worry about this big lease for the next 11 years. According to management, Hyundai got the prime floors of 17th to 20th floor of the building.

The Competitive Leasing Nature in United States – Some changes to disclosure

I think we would be seeing some changes to the way some of the data is presented. While in the past (Q2), we see some disclosure of the average gross rent for each of their buildings and perhaps which buildings have leases that are expiring, the manager has decided to change the way they are presenting.

Ging Wien from ProButterfly wanted to know that for the lease expiry, the percentage of expiry for each property.

Jennifer, the Chief Investment Officer, explained that the leasing scene in the States, is very competitive. If you put it out that in Peachtree, 40% of your tenant will have their lease expiring in 2020 for example, you will see your competitors move in on your tenants.

Thus, the manager has shown some of these data in the past but they are re-aligned with local REIT managers not to show it. This is also to maintain their edge.

I can see where Ging Wien is coming from, and having these information disclosures will help give us clarity on the REIT.

However, if you give so much info, and if what the management said is true, then as a shareholder, you might be shooting yourself in the foot. Ultimately, if you trust the manager, you do not need so much disclosure. However, to build that trust, you first rely on the numbers to tell you whether they are doing a sensible job.

Advance Negotiation for One More Major Lease

Management updates that one of the reason for the “secrecy” is that they are in advance negotiation for a major lease.

We are not sure which is this but let me try to guess.

Michelson have a NLA of 535,000 sqft and 30% are expiring in 2019. This comes up to about 160,500 sqft. Since Hyundai renewed 97,000 sqft, I suppose there is still like 62,000 sqft worth of space at Michelson that needs to be renewed.

So let us see if we have some good news there as well.

On The Impact of Asset Enhancement Initiatives (AEI)

The management updated that they have spent US$8 mil to improve Figueroa on their Lobby, Gantries and New Café, and US$12 mil to improve Exchange on their lobby, Security Desk and LED Lighting.

That is almost 1 quarter of distributable income spent on AEI, but management feels that this is defensive.

In one research article, there are evidence that if AEI was performed and kept competitive, the availability is -9%. For those who didn’t do the effort to keep their building current, the availability is +2%.

Jill, the CEO, updated that usually this kind of AEI should last the building for 10 to 15 years.

Management couldn’t put a value to the performance of the AEI. I guess we shouldn’t view the AEI to be similar to that of sale and leaseback industrial buildings in Singapore. In those industrial buildings, the AEI was carried out, with a tenant committed to rent at a higher rent. So the return on investment is clearer.

On Debt Refinancing and Interest Rate Discussion

In July 2019, Manulife US REIT will have US$108 mil worth of debt, secured on Figueroa reaching maturity. The interest rate was 2.39%.

With the rise in interest rate, it is almost certain that management would have to refinance at an interest rate close to 4%.

In Oct 2018’s article, I guided the average then was closer to 4.39%.

The CFO, Jagjit Obhan explained that one of the good thing that came out of the Tax Cuts and Jobs Act in 2017 was that the REIT’s properties are no longer affected by Thin Cap rule (refer to my article here in one of the section, where I explain more in detail).

The TL DR version Is that the Thin Cap Rule was in place to prevent a lot of shell companies that take on a lot of leverage to funnel money out of the USA. With the tax code changes, this is not needed anymore.

This means that the REIT’s debt need not be secured to an asset. The management proceeded to unencumber the properties.

This is a very good thing for the REIT as it will give the REIT a lot more financial flexibility.

The management is exploring different financing options.

This includes exploring financing options in Singapore. In the past it was rather difficult as a new company to get favourable financing in Singapore, but they manage to overcome that.

Management have guided that recent local quotes range from 4.1 to 4.15% for a 5 years duration fixed USD loan. DBS analyst guided a conservative range of 4.50 to 4.75%.

An analyst was asking whether management would consider refinance to floating rate debt, so that the cost of debt is lower. Jagjit explained that the spread between 2 year LIBOR (2.52%) and 5 year LIBOR (2.54%) is so thin that the REIT will have no benefit by refinance to floating rate. They would rather lengthen the fixed rate loans as much as possible so that the interest expense be more predicable for planning.

They see more benefit to grow the net property income so that the spread becomes wider.

In my previous article, I gave some illustration how the interest rate is staggered so that in the event of a gradual rise in market interest rate the average rental expense rate will take a gradual rise. The interest expense will be offset by organic rental growth, and possibly inorganic acquisitions, such that the overall income yield will still be rising.

The actual implementation by the REIT might differ from this. As you can see the refinance rate of 4.15% might be lower than my projection.

On Potential Acquisitions and Ways to Finance Acquisitions

Based on what I know about the management; they will not purchase an asset without ensuring certain quality to the asset.

Their assessment includes the location, the quality of the building, the amenities around the property, the quality of the tenant and whether that is the tenant mix they want.

With that, I was curious whether with Manulife US REIT’s dividend yield at 7%, whether there are acquisition targets that is accretive but also matches the above mentioned quality.

In the Q4 slide deck, management included this slide to show the CAP rates of Class A properties in various states. When the REIT’s dividend yield is at 8%, acquisition might be challenging but at this point you can see them working a deal with 50% debt and 50% Preferential Offering or Placement and it would be accretive.

Those new to Manulife US REIT such as Kenny (Marubozu) and Ging Wien (ProButterfly) again explain their preference for placements instead of a discounted rights issue.

Management also updated that, during the sell down due to the tax uncertainty, it was mainly the family offices that were selling. The institutional investors were the one that is picking up on the cheap.

So they do have a mix of institutional investors which will make it more conducive for the management to do a preferential offering, or place out new shares to other institutional investors. This will likely not create more uncertainty in the share price compared to a discounted rights issue.

Due to the rather intense competition in United States, if they are able to secure funding fast, it allows them to close good deals, rather than missed out on that. And this is why those REITs who are able to do placements will have an advantage.

The way that I look at it, if the share price approaches US$0.90 again and if the perpetual market is conducive, I can see them making an acquisition that non rights issue.

On a Lower Dividend Pay-out, DRIP, Share Buy Backs

The management is likely to put to shareholders, to give them the ability to do share buy backs in the upcoming AGM. Management would also like to know what we think of DRIP.

Marubozu explained that DRIP would likely be more helpful for the institutional investors but for the retail investors, it is rather challenging because it would create odd lots.

Ging Wien suggested that the REIT should take a precedence to lower their pay-out ratio. As a REIT, the company have to pay out 90% of their income. However, usually the cash flow is more than the income. Ging Wien observe that Singapore is the odd country where the REITs paid out almost all the cash flow. With a low pay out, and the cash conserved, it would allow the REIT to grow at a much faster rate.

My view on this is that, the benefits of DRIP, share buybacks and a lower pay-out ratio is limited. The amount that you saved up is not even enough for one acquisition.

There are benefits if you have a consistent DRIP program, a share buyback mandate but also paying more management fees in cash.

You will gain a lot of flexibility to smoothed the DPU when you need it. This is how Frasers Commercial Trust is able keep the DPU stable when China Square Central underwent AEI, which reduced their occupancy, and the reduction in occupancy in Alexandra Technopark for 1 year.

They basically could get their parent FPL to take shares instead of cash dividend, take management fee in units instead of cash and use the cash proceeds from selling the rights to building the hotel at China Square to sustain a big difference in rental income.

This is one of the reason why DBS guided a more conservative and lower DPU than the adjusted DPU figure announced by the manager. They are being conservative that, the debt refinancing would reduce the DPU, Michelson lower future rent. But the main point is Manulife US REIT paying 50% of their fees in cash instead of 100% in units.

In my opinion, it might not be the low dividend pay-out ratio that made those REITs in USA grow. It is likely of that good quality assets domino effect. The REITs either own a portfolio of good properties that are in demand, have a long WALE. With that, they are able to secure long term debt financing. This profile, increases the demand of the REIT, and so the dividend yield is compressed. This makes acquisition much easier.

The low dividend pay-out has an advantage in that you can show that your DPU will always increase. This is somewhat similar to the concept of dividend aristocrats, which is a group of dividend stocks that were able to consecutive raise their dividend per share over a long period of time.

If your pay-out ratio is low, and slowly raised pay-out, people think that the dividend is safe, when in reality a part of your potential dividends were retained.

Due to the size of some of these REITs, they are able to use the retain cash flow to do development. This adds on to the growth.

IREIT global tried to do this by reducing their dividend pay-out ratio to 90%. They retained the cash, but since Tikehau took over the REIT, they have made zero acquisitions with those cash.

I think they could take another approach. Build up a portfolio of good quality assets with very long WALE. Match that with longer term financing. This kind of stability and attractive dividend yield, act as an attraction to institutional investors who needs these kind of assets. The demand increases, the dividend yield gets compressed. Due to the quality of the asset, the property value gets revalued upwards. This creates more room to purchase accretive assets.

In this model, the high dividend pay-out act as a form of signalling. This strategy will only work out well in the long run if the portfolio is real quality. If the quality of the property, manager, and tenant based is lacklustre, such a strategy will collapse like a house of cards.


I think overall, the results didn’t come as a surprise. A US 3.04 cents dividend was declared, which averages US 1.52 cents per quarter.

The challenge is to guess what would next year’s dividend per unit be. Manulife US REIT’s DPU would be affected by approximately 1% more due to the change in Barbados tax structure, the lower passing rent of Hyundai’s lease.

They will also be affected by a higher interest expense from Figueroa’s refinancing.

Based on my simulation, they could possibly see a 0.28% rise in interest expense. If you add these 3 up, the impact could possibly be -1.74%. I do think they organic rental reversion of 2.1% could offset this.

It is certainly better to write a review without covering so much uncertainty in a REIT. The bad part is that share price seem to have recover, and that would mean prospective investors or investors who wish to increase their stake would find it hard to do so. We would have to hope for another mispricing opportunity.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often.

Here are My Topical Resources on:

  1. Building Your Wealth Foundation– You know this baseline, your long term wealth should be pretty well managed

  2. Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience

  3. Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors

  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG

  5. Free Stock Portfolio Tracking Google Sheets that many love

  6. Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free

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Manulife US REIT and Keppel KBS Announced Minimal Impact from Section 267A Regulations and Barbados Tax Rate Changes
- Original Post from Investment Moats

In my recent articles on Manulife and Keppel KBS, I highlighted a potential tax complication that could have an adverse impact on both REIT’s dividend yield.

Both REITs own office properties in United States and have set up certain corporate structure to optimize the taxes that they have to pay.

However, in Dec 2017, there was a big change in the United States tax code. TheTax Cuts and Jobs Act (TCJA),was one of the biggest change to the tax code since 1986.

There were a few sections in the newTax Cuts and Jobs Act (TCJA) that affect Manulife and Keppel KBS. (You can read more about the layman explanation in detail in my article here)

To address section 163(J), both REITs restructured their United States property ownership structure to be flat, thus eliminating the impact of interest deduction limit.

To address section 267A on the tax deductibility of interest expenses on the United States entity, both REITs restructured to have an intermediate Barbados entity. As long as the income received by the Barbados entity is taxed, the United States entity can use the interest expense as a tax shield, reducing the tax payable and preserving the dividend.

These changes to the tax code can be rather ambiguous to those trying to file taxes. Thus, the IRS will come up with tax clarifications to guide what is allowed and not allowed.

Manulife and Keppel KBS have warned that the clarifications to section 267A could potentially have adverse material impact in terms of reduction but reduction of dividend.

US Tax Office Released Proposal for Section 267A

On 20th Dec 2018, , IRS have submitted their tax clarification proposal related to section 267A. This proposal is currently in unpublished status but will likely be published tomorrow.

Since this announcement should be released soon, I tried to keep in touch with it.

You can read:

  1. Proposed regulations implementing sections245A(e) and 267A of the Internal Revenue Code (“Code”) regarding hybrid dividendsand certain amounts paid or accrued in hybrid transactions or with hybrid entities (154 pages)

  2. KPMG report: Initial impressions, proposed regulations implementing “anti-hybrid” provisions of new tax law

I read through those two documents. I looked through the different examples of what constitute a CFC, what would consider a hybrid entity or hybrid transaction. I looked at the examples given.

My conclusion is that the scenarios painted, that would make these 2 REITs be deemed as a hybrid entity, would not make them look like a hybrid entity. And thus, both REITs should be able to use interest expense as a tax shield.

The impact to their dividends should be limited.

Change in Tax System for Barbados

In my research on these tax issues, I realize that the international government is coming down hard on some of these tax havens that provide preferential tax rates.

Some of the common ones are countries like Barbados.

Last year the OECD included Barbados on its list of jurisdictions with a “harmful” preferential tax regime, and said the Barbados system was in breach of its Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (BEPS) rules. The BEPS system was designed by the OECD to prevent jurisdictions offering “preferential tax regimes.”

Basically, Barbados have 2 different taxes. One for the domestic folks (30% corporate tax) and one for the international regimes (0.5% to 2.5%, this is the one Keppel KBS and Manulife restructured to). So you can see why the OECD is not very happy.

It should be noted that the US tax office somewhat take reference to the OECD’s BEPS guidelines, published in 2015. Thus, if Barbados bring themselves in compliance with OECD guidelines, then it should be OK with the US Tax code.

The government of Barbados announced that they will be in compliance with OECD by end of the year.

Barbados decided to reduced their domestic corporate tax to that of their international corporate tax. Essentially now, there is one set of corporate tax structure only.

As a result of the move toward convergence, most corporate entities in Barbados will be taxed on a sliding scale of 5.5 per cent for those companies with taxable income up to BDS $1 million (US $500,000) down to 1 per cent for those with taxable income over BDS $30 million (US $15 million). Insurance companies will be taxed at a rate of zero to 2 per cent depending on their class of business.

It should not be hard to guess that the international business far outweigh that of their domestic, so they have to swallow this bitter pill.

We will eventually know that Manulife’s tax will increase from 1.5% to 2.5% as a result of this change in the Barbados tax system (see below).

Manulife US and Keppel KBS makes Announcement

This morning both Reits made individual announcements through SGX regarding tax clarifications.

This is Manulife US REIT’s announcement at 7:46 AM this morning:

Management highlighted that there should be an additional tax expense of no more than 1% of distributable income before income tax, due to the change in Barbados Tax Rates. There should not be any increase in costs, to restructure the corporate structure to optimize taxes. They end off with a disclaimer that the release is in proposed form and the finalized report should be ready by 22nd Jun 2019. If there are changes, then there might be material impact.

This is Keppel KBS announcement at 8:19 AM:

You do realize just how similar Keppel KBS’s announcement is. It is as if they just replaced Manulife with Keppel-KBS, and change the 1.5% current tax paid to 1.2%.

I honestly do not believe 2 companies can timed their release so close together.

When I got wind of this proposal, it was 5 days ago, 2 days after the proposal was published. It is not as if the proposal was published yesterday night.

What are the Risk of Drastic Changes in the Finalized Regulation?

One question that is on my mind was that, given the disclaimer at the end, it does raised the possibility that there may be drastic push back or amendments to line items in the proposal.

In an analyst report published yesterday by Deutsche Bank, Manulife US REIT notes that IRS initial proposals tend to be more conservative, with final regulations having the potential to be more lenient as additional clarifications and guidance be issued.

So likely, based on their experience with the IRS, they do not see a lot of drastic changes that would result in material impact.

Manulife US REIT’s Management should be able to Mitigate the Increase in Costs Well

In the same report, management also believes that they will be able to mitigate most if not all of the impact via depreciation shields and restructuring of holding companies.

What is of note is that, perhaps after the finalized regulation is out by 22nd June 2019, the management can “move more aggressively in tax planning”, “potentially reverting to a structure where it enjoys nearly full tax transparency“.

My England is not so powerful, but by reverting it does mean a reversal to a structure previously. If I understand correctly, under the previous structure, it will entail the income paid to the Singapore parent to be a hybrid transaction. Yet, this reversion would potentially make them enjoy full tax transparency, which means we might go one big round and end up back to square one, without the Barbados entity.

I do not know how that would work out, but if they know what they are doing, then I am not going to pretend I know enough to provide an opinion.


Manulife US REIT ended the day at $0.745 and Keppel KBS at $0.57. One provides a dividend yield of 8% the other nearly 10%.

With this clarification proposal, we have a lot more color about this potential negative risk to both REITs (and perhaps other companies affected by this)

This increases the risk adjusted returns of these two REITs.

One last question that may be on your mind is, how much is the uncertainty that the tax code would gyrate again. If we look to history, the last major change in tax code was in 1986, after much pressure. This tax code change in 2017 was the one after that, and that happened 31 years after the last one.

The tax code change in 2017 is a large one, and I think it is likely we would not see drastic changes to the tax code of this nature very frequently. (However, with Trump, there is always some freakish uncertainty)

The rest of my REITs stuff, probably can be found in Learning about REITs below.

Do let you know what you think of this.

DoLike MeonFacebook. I share some tidbits that is not on the blog post there often.

Here are My Topical Resources on:

  1. Building Your Wealth Foundation– You know this baseline, your long term wealth should be pretty well managed

  2. Active Investing– For the active stock investors. My deeper thoughts from my stock investing experience

  3. Learning about REITs– My Free “Course” on REIT Investing for Beginners and Seasoned Investors

  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG

  5. Free Stock Portfolio Tracking Google Sheets that many love

  6. Retirement Planning, Financial Independence and Spending down money– My deep dive into how much you need to achieve these, and the different ways you can be financially free

$ManulifeReit USD(BTOU.SI)

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My Manulife US REIT Analysis
- Original Post from Investment Moats

Manulife US REIT is a unique commercial office REIT.
The dividend per unit is about US$0.06. At current share price of US$0.845, the dividend yield is 0.06/0.845 = 7.1%.
The dividend yield might not look like much but as an investor, you might be interested in its profile:

  • As of Mar 2018, 120 tenants

  • 7 commercial office properties

  • Land Tenure is freehold

  • Weighted Average Lease Expiry of Tenants 6.3 years

  • Average rental escalation of 2.7%

  • Nature of leases tend to be 3 to 10 years

  • Debt to Asset of 37%

  • 100% Fixed Debt

  • Weighted Average Interest Rate 3.27%

  • Build in CPI or Fixed Rental Escalation

  • USD Denominated

Because of its unique nature, shareholders need to submit a W8-Ben form to indicate that they are a non-US citizen. Failure to submit the form, your dividend would be subjected to a 30% withholding tax.
Here are some of my short thoughts about it.
My analysis, are usually pretty jumbled up. It helps more for investors who are interested and have done some homework.
For those who are new to the blog, usually after reading my analysis, you will have 2 different feelings, steer clear of this stock, or make you want to queue tomorrow. This analysis does not constitute a recommendation to buy and sell. You should analyze further on your own, make your own buy and sell decision.

Poorer Q1 2018 Financial Results Pulled Down by Figueroa and Michelson

Back when they announced the Q1 result, I sold out fast because from what I see, the result was tad disappointing.

While distributable income when up due to the contribution of Plaza and Exchange, the distribution per unit was lower due to lower income as Figueroa and Michelson had lower occupancy.
The result is also lower due to higher income tax, likely due to the change in tax structure after President Trump announced some tax changes.
My thinking is to be quick on the trigger for new REITs.
There are some REITs that, on paper, showed a good value proposition. Good properties, good lease terms, favorable gearing and operate in an environment with good growth.
The problem is sometimes they are too good to be true. To list in Singapore and attract investors, you can dress them up well so that folks like myself would like that.
You can get invested, and see how they work out, or stay on the sidelines. If you get invested, layered your funds in and if you still have not sense whether the management is working in your favor, be more quick to sell.

Much Better Q2 2018 Financial Results

Last week, Manulife announced a much better set of results. Well, not very much better but it didn’t show a consistent decline in dividend per unit.

We are able to see not just contribution from Plaza and Exchange but also 9 days of contribution from the recent acquisition in Penn and Phipps. If you compare the net property income of this slide 2Q and the net property income of the slide above in 1Q, the difference might be the contribution for 9 days.
If we expand that out to 90 days instead of 9, it does seem significant.
However, it can get tad confusing chasing the figures because in Q1, there was a rights issue, so the number of outstanding units expanded. In Q2 there was a preferential offering as well, so the number of outstanding shares expanded.
So the adjusted DPU is a reflection of the enlarged unit based. However, we won’t know what is the eventual distributable income until perhaps next quarter.
If we annualized the DPU it is U$0.0612 for a dividend yield of 7.25% based on U$0.845.
I think the results would not be that power, due to some rough computed figures.

Feeling the Effects of Rising Interest Rates

In various parts of the world, the central banks have already tighten their money supply. In the US, reverse quantitative tightening is taking place.
This has taken interest rate up.

In Deutsche’s report, they do highlight that management updates a debt maturing in 2019 is coming due, and the current base rates have gone up by 2%! This would add like U$2 mil in interest expense.

Future Organic Rent Growth

Organic rent growth for the properties will come from:

  1. renewing leases

  2. mid term rent review

  3. rental escalation

  4. asset enhancement initiatives

As most of Manulife’s leases are rather long, we would seldom see any reversion through renewing leases.

The slide above shows the 3 leases that were renewed this in Q2 2018. This looks good.
What is interesting is that in Q1 2018, the results was not good based on what was stated in the fine print of Q1 2018 income statement.
So I am not sure if someone made a comment to management to ask them to show this, or its a deliberate attempt to show only the good stuff.

The slide above shows a snapshot of the nature of each property.
While the WALE is long, for each year there is about 6-8% of Manulife’s Gross Income expiring. Thus it presents an opportunity for growth, or negative growth.
So the upcoming one is Michelson in Irvine. 30% of it is coming up for rent renewal.

The table above shows the existing gross asking rent for the class A inventory in the region. I have put in the figures for the Q1 and Q2 average asking rent for Manulife’s offices.
If we compare the gross rent for Q2 average rent versus the Q2 gross asking rent for the same region, 5 of Manulife’s properties look under rented. 2 of them looks like their passing rent is higher than the gross asking rent.
The biggest disparity seems to be Irvine, or where the 30% is expiring next year.
Recall that what pulled down the performance in Q1 2018 was the renewal at Figueroa and Michelson and if Figueroa is doing ok in Q2 2018 renewal, does that mean we are going to see some major negative rent reversion coming.?

DBS seem to note the decline in occupancy at Michelson and Figueroa.

Deutsche notes that Michelson has a large tenant in Hyundai Capital America that they would wish to forward renew to manage the risk and reward.
I also tabulated the Q1 vs Q2 average rent. The rent seems to be always heading upwards, this is probably due to the rental escalation built in.
If there is any takeaway from this section, there are some questions that you can pose to management about whether the lower occupancy is a fall off in demand, an inability to get new tenants at market rates, or whether there is a separate rent for trophy buildings like Michelson.

Manulife US REIT is a Beneficiary of Favorable Currency Movement

Numerous Singapore listed REITs have expanded their mandate to include properties that are overseas.
This increases the variables of consideration:

  1. While the net property income yield can be higher

  2. The currency movement might negate it

  3. The future growth prospect of the region and sector might also be a consideration

  4. The interest cost for foreign denominated debt is another factor

So sometimes, I do feel that it is a zero sum game. You might get a freehold and higher cap rate property, but the currency might not work in your favor.
You could hedge that volatility in that currency, but there are hedging costs as well.
Manulife US REIT’s rental is in USD, and its debt is in USD, so there is a natural hedge there.
Since the REIT is listed in USD denomination, you could get paid in USD.
However, if you were to spend it, you would have to convert to SGD.

After a 1.5 years of devaluation versus the SGD, the USD have strengthen against the SGD. If we expand to a 3 year time frame the currency trade in a tight band versus the SGD.
Future direction of the currency pair is always hard to tell, as it is influence by a few macroeconomic factors.

I have provided a snapshot of the expectation of a BCA or bank credit analyst report of the short term and longer term direction of the currency. My honest assessment is that if you are buying the REIT and you do not wish to be negated by the currency fluctuation, there needs to be deeper analysis to be carried out. And I wonder if you would want to do something like that.
However, if Manulife US REIT is a pretty good quality REIT with good management, you can see yourself hedging your currency exposure of another foreign REIT with this. For example, the most depressing forecast have been the AUD, and we know that there are a lot of Singapore REITs with properties down under.
It might be an idea to balance that with a REIT like Manulife or Keppel KBS.

Could Manulife US REIT’s Ability to grow be Impeded by General Interest?

Back about 1 year ago, Manulife US REIT had organize an investor day.
I believe those that left the presentation that day, about what are the plans of the management going forward were optimistic about what they wish to do.

The above paragraphs was extracted from a February analyst report. It states that the management had the plans to grow their assets under management to U$1.8 bil. That would roughly be double the AUM currently.
The reason, is that without a particular size, certain levels of funds cannot get invested. With the availability to tap these funds, Manulife can have a easier time raising equity placement, preferential offerings to acquire and grow.
Without these funds, you can only grow so much with debt. Manulife US REIT debt to asset currently stands at closer to 37% so there is not a lot of room to maneuver if they wish to be conservative and keep the gearing below 40%.
This is not new, and one of the key reason Singapore Industrial REIT ESR REIT is trying to merge/acquire its way to have a larger AUM.
Usually, when the REIT is small, it has to rely on debt and heavily discounted rights issue. One good example was First REIT. First REIT did one or two 50% discounted rights issue, which allow them to increase their AUM. Once that is done, they have more debt headroom, and ability to acquire with equity.
However, this is a chicken and egg situation.
In order to acquire you need to be big. In order to be big, you need to be big.
I think everything will have to start with

  1. having assets that investors deem as attractive

  2. a market with attractive and undervalued assets that can justify to investors to add onto the trust

Manulife is running into a few problems. They are trying all sorts of ways to become big.
Their prevailing dividend yield is around 7%. The good quality USA commercial office properties yield less than 6% with the ones in good area hovering around 4-5.5%. In order to make it accretive, they cannot finance it 100% with equity. If you do it with 50% debt and 50% equity, the incursion of this new property will increase the dividend per unit for existing shareholders.
In their acquisition of Penn and Phipps, the management’s original idea was to finance with a combination of equity, fixed debt and perpetual securities.
However, they have to abandon the perpetual securities route, and decide to do a large round of rights issue.
The main reason is that interest rate in the USA have moved up a lot. For example, in the latest quarterly results, the management have updated that there are some fixed duration debt expiring in 2019. However, the interest rate now is 2% higher than previous.
You can imagine the corresponding rate of perpetual securities to make investors willing to invest in perpetual securities.
Manulife US REIT is currently trading below the theoretical ex rights price (TERP)of U$0.88. Before its ex dividend recently, the rights was trading at the rights issue discounted price of U$0.865. The prevailing share price during the announcement was U$0.93. If you are a shareholder, it means you should have sold at above U$0.90 and get invested at current price.
To put it philosophically, if you think the REIT is good, what you are getting now is at an even more heavier discounted price.

The above chart shows the recent 1.5 years price movement of Manulife US REIT. When the interest for the REIT picked up in 2017, it becomes a very positive environment for the management to raise money to grow their AUM.
From my close observation, back then the prices was pretty strong. Even after the offering for the purchase of Plaza and Exchange the prices rebounded.
This recent capital raising exercise seem to have reversed that.
Now you wonder, without support and adequate interest, how do you raised money through equity without giving away so much discount?
If the REIT do not grow, then how do they reach the size that makes equity raising easier?
It would seem size and capital support are very important factors when it comes to REITs.
Having a mandate to operate in attractive areas is also important.You do not want the manager to purchase a high net property income yielding asset just for it to be near term accretive only for the REIT to have issues leasing it out down the years, or losing value down the years.
Buy quality at reasonable unleveraged yields.

The Market Seems Hot Still

And that would mean that the management will have a hard time securing quality property at reasonable yields.

In Deutsche’s report, management update that there are still a lot of capital looking to invest in USA. A prospective asset that they are looking at have compressed from 6.5% to 6% yield.
We are not sure if we will see them proposing this acquisition to us, but this does seem higher than the cap rate of the properties that Manulife US REIT have been acquiring in the last 2 proposal.

Analyzing the Unleveraged Net Property Income Yield

The above table shows the change in valuation of the properties owned by Manulife US REIT. It also shows the implied cap rates for the sub markets that the properties operate in.
The overall portfolio average cap rate is 5.3%, which is down from 5.5% in Dec 2017.
Cap rates can be rather confusing but in this case, you can take cap rates as the market average net rental income divided by the market average property asset value. For example, the implied cap rate for Penn was 5% in 31 Dec 2017. It narrowed to 4.8% when Colliers took over in 2018.
Going by how you calculate cap rates, you can see why it is often termed as net property income yield.
Since cap rate = net rental income / market value of the property, if you re-arrange you can get the market value of the property by net rental income / cap rate. Thus, if you know that for the last year your property in Washington earns $1000, the market value of your property is $1000/0.048 = $20,833.
A compression of cap rate means your property can fetch a higher value.
However, some owners (not just owners of REIT) tend to be very optimistic and use a particularly low cap rate. Your property value will look higher, and with higher property value, you can borrow more. Of course, if your property value is inflated, when the tide turns it could get pretty ugly.
So what cap rate to use sometimes is part art, part maths, part data, part conspiracy theory.
The value I can get from this slide personally is that at least now I have an idea what are the rough net property income yield for the recent acquisitions (Exchange, Penn, Phipps). In the slides for the propose acquisition, this was not stated. Thus, shareholders have a freaking hard time telling what is the yield of these properties.
The cap rates vary between 4.4% to 6.6%. Its probably not right to say that 4.4% is overvalued while we should go into an area where the cap rate hovers above 6%. The managers probably need to consider more things such as the demand and supply dynamics and the future growth of the city.
As a comparison here are the cap rates for various property owning businesses:

  • Keppel REIT (Ocean Financial Centre, MBFC, One Raffles Quay, Bugis Junction Towers): 3.75%

  • Keppel REIT (Australia long lease properties): 4.5% to 5.6%

  • Capitaland Commercial Trust: 3.5% to 4%

  • Hong Kong Land (high grade HK Office): 3.25%

  • Hong Kong Land (high grade SG Office): 3.25%

  • Cheung Kong Assets (high grade Office): 4.75%

  • Keppel KBS IPO Jun 17 (Washington): 5% to 5.75%

  • Keppel KBS IPO Jun 17 (Austin Texas): 6.5%

  • Keppel KBS IPO Jun 17 (Houston Texas): 7% to 8.5%

  • Keppel KBS IPO Jun 17 (Atlanta Georgia): 6.75% to 7.75%

Colliers, the new valuer compress majority of the cap rate in different areas. This would normally increase the value of the properties. However, Figueroa and Michelson did not show an increase in value.
Colliers assumed that income, in terms of rents and vacancy rates, might be going down and up respectively.
Plaza and Exchange, both in New Jersey saw their cap rate expand. Normally this would mean the asset value goes down. However, in their case their asset value went up. The reason is likely the opposite where the income and vacancy situation is assumed to be better.
Peachtree and Phipps saw the same cap rates but higher valuation. The valuer probably assume the income will be higher.
Washington and Orange County showed the largest negative net absorption. This makes Michelson more of a worry if the large renewal next year is coming up.
Management do feel that the absorption figures are misleading as they think a few entrants may take up disproportionately large spaces and the absorption figures should be interpreted over the longer term. Management thinks that Penn caters to the price sensitive tenants in the region. Orange county, which is close to other submarkets, might see tenants transferring between them. As a result the figures might vary a fair bit.

Why Doesn’t Capital Expenditure Factor into Manulife’s Free Cash Flow / Available Income for Distribution?

I was browsing Manulife US REIT’s dividend distribution announcement and its cash flow statement.
I felt that something do not add up.

In the summary of group results, it is listed that the income available for distribution is 16.5 mil and 9.9 mil respectively. This is the amount Manulife deems that they can safely pay out as dividends. They can choose to pay less.
Usually, this amount is computed based on adjusted funds from operations (AFFO for short) which is close to what we called free cash flow when we are analyzing companies.
So its good that we do a sanity check to ensure the company is doing something conservatively.

If we look at the cash flow statement for 2Q 2018 and 2017, if we take the operating income bef working capital changes and deduct the tax paid and interest paid, we arrive at 16.3 mil and 9.6. mil.
This is very close to the income available for distribution in the summary. This is what we term net operating cash flow or funds from operations (FFO for short) in the REIT context. By right, we should still need to deduct the maintenance stuff that Manulife carried out for the building.
If that is the case, why was payment for capital expenditure and other costs related to investment properties of 2 mil each excluded from the computation of income available for distribution?
If a REIT is operated conservatively, it should be paying out of AFFO or free cash flow, which would mean to payout after the necessary maintenance capex is spent.
In this case it does not seem to be the case.
Like many things, I cannot clarify with the investor relations because they did not respond to my email every time. This would be something that you guys would wish to bring it up to them.

The Appeal and the Risk of a Unique Tax Structure

The diagram above shows the tax structure of Manulife. Dividends that are repatriated from the USA are subjected to a 30% withholding tax.
You can verify this if you are one who invest in stocks in the US stock exchange.
However, there is a way to circumvent this if you are a REIT. To be a REIT you have to pay a large part of your income out as dividend, and no single investor can hold more than 9.8% of Manulife shares. This includes the sponsor.
The company can create a USA corporation and the Singapore Manulife company loan this USA corporation. This USA corporation then purchase the properties.
Since it is structured as a loan, the USA corporation pays the Singapore Manulife company in interest payment, which is currently exempted to tax.
Now, foreign source dividend (in Singapore context) is currently not subjected to tax. This is consistently reviewed for 5 years.
However, I believe I read that there must be some agreement carried out with IRAS to effect this concession for a longer duration.
It cannot be the case that after 4 years, the government decide that they would tax everyone. Then this REIT would suffer because its dividend would most likely be lower than compare to the current situation.
It sort of gives you another layer of uncertainty. However, this is not affecting only Manulife. First REIT and LMIR was the subject to changes in taxes which adversely affected LMIR’s cash flow and share price. The same with Mapletree North Asia Commercial with the VAT tax in China.
If your REIT has property overseas, and most REITs in Singapore has that, you will be affected by these taxation changes.
Or rather, it will be difficult for you not to be affected by these potential tax changes.


We always wonder why, Manulife would come over to Singapore to list a REIT of assets in US. This despite having the largest REIT market back in their home town.
The main reason that was communicated is the REIT, acts more like a marketing concept to compete in the insurance business in the region. If they do well, it will improve the branding in the region.
With this motivation, they have some incentive to ensure that this REIT is not badly managed.
This REIT is on a growth trajectory, however there are still a lot of questions. How do you grow when there is a rising interest rate environment? Could the manager improve the property organically? If there are some large vacancy, could they successfully lease out the space for a good tenure?
The price have came down a fair bit, the dividend yield is attractive. However, due to the volatility of the currency, rising interest rate, it might not always be very clear this is a buy. If you look across the pond, another locally listed USA REIT, Keppel KBS seem to have a much higher dividend yield after its share price came down 10%.
Let me know what you think, and what other angles I failed to consider.
My consolidated resources on:

  1. Building Your Wealth Foundation

  2. Active Investing

  3. Learning about REITs – My resources about all the details of REIT investing

  4. Dividend Stock Tracker – Track all the common 4-10% yielding dividend stocks in SG

  5. Free Stock Portfolio Tracking Google Sheets that many love

  6. Retirement Planning, Financial Independence and Spending down money

$ManulifeReit USD(BTOU.SI)

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Did a summary of the portfolio of purchase by $Frasers L&I Tr(BUOU.SI) . Overall it does not do much to the returns. Rather it diversifies the portfolio. I do find the price purchase to be rather dear. Compare to that of $ManulifeReit USD(BTOU.SI) recent purchase, which seems to have a higher NPI Yield.


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