Prime US REIT: Challenging times remain
- Downgrade to HOLD rating; TP of US$0.18
- 1H23 DPU -30% y-o-y, in line, higher base fees paid in cash
- Lack of re-rating catalyst along with concerns of limited buffer in asset valuation decline to 45% gearing
- Key data to watch: i) Lower occupancy, ii) debt refinancing in FY24, iii) major tenant’s lease expiring at year-end
Related Stories
- 1H23 headline DPU -30% y-o-y to 2.46 UScts, in line with our estimates, largely due to PRIME raising the management fees paid in cash from 20% to 100%.
- On a like-for-like basis, estimated DPU -24% y-o-y on higher interest cost, and lower revenue (-3% y-o-y) and NPI (-7% y-o-y).
- On a q-o-q basis, 2Q23 estimated DPU fell 3%. 2Q23 revenue fell 2% while NPI was relatively flattish at -0.2%.
- Gearing improved marginally by 0.9ppt to 42.8% from 43.7% in 1Q23.
- It successfully extended the maturity of the US$400m term loan and revolver by another year, to mature in Jul 24. This gives PRIME more time to secure refinancing in the hope that the macroeconomic outlook and US office sector could see a turnaround.
- All-in interest rates stayed relatively stable at 3.9%, vs. 3.8% in 1Q23.
- The hedging ratio remained stable at 80%, vs. 79% in 1Q23 (63% is hedged/fixed from 2025 to 2026).
Key highlights/observations
Portfolio occupancy fell to 85.6%; leasing activity remained muted in 2Q23 but extended largest tenant’s lease by 3 years in Jul 23; Sodexo’s (3rd largest tenant) lease expiring in Dec 23
- Portfolio occupancy fell by 3ppt q-o-q to 85.6% from 88.6% in 1Q23. The larger movements in occupancy were mainly from Park Tower (-11ppt q-o-q to 74.3%), 171 17th Street (-15ppt q-o-q to 80.5%), and Tower 909 (-3.7ppt q-o-q to 84.0%), partially offset by an occupancy improvement at 222 Main, Promenade I&II, and Sorrento Towers, with each property’s occupancy +c.2ppt q-o-q.
- Leasing activity remained slow in 2Q23, with PRIME signing c.67k sqft of leases, vs. 64.4k sqft in 1Q23. However, we note that PRIME renewed the lease of its largest tenant, Charter Communication, in Jul 23, with an extended three-year lease.
- The lease expiries remaining in FY23 have reduced to 9%, the largest of which is attributed to PRIME’s third largest tenant Sodexo, whose lease is expiring in Dec 23. The lease contributes c.5.3% of cash rental income (CRI).
- PRIME recorded strong positive rental reversion of 9.5% vs. -2.6% in 1Q23. 1Q23 reversions would have been +3.2% excluding two renewals with minimal upfront tenant improvements (Tis), which have high positive net effective rental reversions. Management remains focused on net effective rents and embarked on asset enhancements, provided more efficient and selective amenitisation, and intensified tenant engagement with community activity with the aim of retaining existing tenants and attracting prospective tenants to their assets.
- Passing rents were 6.7% below that of market rents (vs. 6.8% below in 1Q23). Most assets are under-rented, except for Reston Square, One Washingtonian Center, and 222 Main.
- Management has observed some greenshoots in the US office market, with increased leasing discussions for larger leases, albeit with longer lead times. Physical occupancy is improving slowly to 58% as at 4 Aug 23. More companies have mandated (at least hybrid) return to work. Similarly, larger tenants within PRIME’s portfolio, such as AGG, Goldman Sachs, Matheson, and Teleflex have mandated a return-to-work policy.
While PRIME has a gearing and ICR buffer before it hits the MAS limit of 50% and 2.5x, respectively, and the extension of the debt expiry has somewhat alleviated debt refinancing risks for now (extended to FY2024), we are concerned that a buffer of only a 5% asset valuation decline for gearing to hit 45% (15% to hit 50% gearing) could be insufficient to comfort investors. In addition, the deterioration of portfolio occupancy may elevate potential risks to the asset valuation.
We will continue to monitor the situation for any potential re-rating catalysts, such as i) stronger signs of a recovery in the US office market, ii) the Fed pausing/cutting interest rates, and iii) an improvement in macroeconomic sentiment/outlook.
FY Dec | 1H2022 | 2H2022 | 1H2023 | % chg yoy | % chg hoh |
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Gross revenue | 81.8 | 81.2 | 79.5 | (2.9) | (2.1) |
Property expenses | (31.0) | (34.1) | (32.3) | 4.2 | (5.3) |
Net Property Income | 50.8 | 47.1 | 47.2 | (7.2) | 0.1 |
Other Operating expenses | (5.5) | (5.2) | (4.4) | (20.9) | (15.5) |
Other Non Opg (Exp)/Inc | 26.4 | 10.8 | (1.6) | nm | (114.6) |
Associates & JV Inc | 0.0 | 0.0 | 0.0 | - | - |
Net Interest (Exp)/Inc | (10.1) | (11.5) | (13.6) | (34.6) | (18.3) |
Exceptional Gain/(Loss) | 0.0 | 0.0 | 0.0 | - | - |
Net Income | 61.6 | 41.3 | 27.6 | (55.2) | (33.1) |
Tax | (4.5) | 18.3 | 0.0 | (99.2) | nm |
Minority Interest | 0.0 | 0.0 | 0.0 | - | - |
Net Income after Tax | 57.2 | 59.6 | 27.6 | (51.8) | (53.7) |
Total Return | 57.2 | (84.1) | 27.6 | (51.8) | (132.8) |
Non-tax deductible Items | (15.9) | 120 | 1.65 | (110.4) | (98.6) |
Net Inc available for Dist. | 41.3 | 35.8 | 29.2 | (29.3) | (18.4) |
Ratio (%) |
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Net Prop Inc Margin | 62.1 | 58.0 | 59.4 |
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Dist. Payout Ratio | 100.0 | 100.0 | 100.0 |
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Source of all data: Company, DBS Bank
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