Prime US REIT: To ride the storm
- 3Q22 estimated DPU -5% y-o-y to 1.63 UScts, mainly due to lower occupancy, in line
- Vacated WeWork space is 2/3 backfilled and lease likely to commence soon; portfolio occupancy stable with 2 buildings, improved to 95%; interest rates are significantly hedged/fixed until mid-2024
- Watching out on lease expiries in FY23 and if tenant incentives are rising in line with cost increases
- Maintain BUY; lower TP to US$0.65
Related Stories
- 3Q22 estimated DPU -5.2% y-o-y to 1.63 UScts, in line with our estimates, mainly due to vacancies including WeWork, which vacated in 4Q21, and Whitney Bradley & Brown, in 3Q22.
- Gearing inched up marginally by 0.9ppt to 38.7% vs. 37.8% in 2Q22.
- Effective interest rates inched up q-o-q to 3.1% vs. 2.8% in 2Q22. All-in average cost of debt inched up marginally q-o-q to 3.2% from 3.1% in 2Q22.
- Hedging ratio at 83% as at 3Q22 with fixed rate (hedged/fixed) expiries in mid-2024 to 2029 (66% is hedged/fixed through to mid-2026 and beyond).
- Refinancing risks are largely mitigated as debt facilities have one to two years of extensions. As such, the next refinancing requirement (67% of total debt) will be in 2024.
Key Highlights/Observations
Portfolio occupancy stable q-o-q at 89.6% with WeWork’s space being 2/3 backfilled offset by WBB’s departure; maintained strong positive reversions at 10% but will look to provide lease incentives to drive occupancy
- Portfolio occupancy held stable at 89.6%. Portfolio occupancy held stable q-o-q at 89.6%. Occupancy at Reston Square fell to 47.1% with the departure of Whitney Bradley & Brown, as previously guided. PRIME signed a new lease at Tower 1 at Emeryville with the new tenant taking up two out of three floors from WeWork’s previous space and it will likely commence soon. As such, occupancy increased to 77.1% from 58.9%. We note that occupancy in 3Q22 at some buildings (101 South Hanley and 171 17th Street) saw improved to c.95%.
- Signed 246.2k sqft in 3Q22, led by the new lease at Tower 1 at Emeryville, which will likely commence soon. PRIME signed leases for 246.2k sqft, close to that of total leases signed in 1H22, mainly led by the new lease at Tower 1 at Emeryville. Leases of 95.1k sqft (c.39% of leases signed in 3Q22) will commence in 2022, while the remaining is expected to commence in 2023.
- PRIME has minimal lease expiries remaining in FY22 and is currently working on the upcoming lease expiries in FY23, 15.9% of CRI. We understand that management is in talks with one of the major tenants with lease expiries in FY23.
- Short-term leases maintained at 3.8% of NLA or 2.4% of CRI.
- Strong positive rental reversions continue, recording +10% vs. +10.9% in 2Q22 and +3.4% in 1Q22. Passing rents are still 6.7% below that of market rents. However, management may provide lease incentives to increase occupancy. IT costs have seen an increase in tandem with higher renovation costs.
- Return to office has been slower than expected but remote work is showing signs of losing momentum post Labor Day, according to JLL. As at 3Q22, physical occupancy ranges between mid-20% to a high of 70%. Management has seen uptick in physical occupancy post Labor Day in some buildings within the portfolio, in line with the observations in the market.
- While there are no meaningful transactions in the market, management expects some cap rate expansion towards the end of the year given the sharp increase in interest rates.
Maintain BUY; lower TP to US$0.65. We maintain our BUY rating but lower our TP to US$0.65 from US$0.88 previously, to factor in a higher risk-free rate and interest rates. We lower our FY22F-FY24F DPU by 2% to 12%, taking a more conservative stance to factor in potential vacancies, some impact from higher floating rates, and slower recovery post 2024.
PRIME’s share price has declined close to 50% YTD. Currently, it is trading at the FY23F headline yield of c.14%, based on our conservative estimates. Our target price implies a yield of c.10% in FY23F. At these levels, we believe the headwinds are largely priced in and it is at an interesting level to monitor for any potential short-term inflection in macroeconomic sentiment/outlook.
Despite the challenging environment, PRIME has substantially hedged its interest rates to mid-2024 and will take some initiatives to enhance some assets to attract tenants and employees back to the office.
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