Manulife US REIT halts distributions. What's next for the US office REIT?

What happened?

Manulife US REIT, or MUST, a Singapore-listed US office REIT, has announced that it will not pay out any distributions for the first half of 2023.

There are two key reasons for the manager’s decision.

The first involves the breach of a financial covenant in MUST’s financing documents.

The second reason is that the REIT manager cannot confirm that the REIT can fulfil its liabilities should a distribution be paid.

It is highly unusual for a REIT to stop its distributions as most REITs aim to pay out consistent and dependable distributions to its unitholders by owning and managing a portfolio of properties that generate rental income.

Let us dive deeper to understand what are the challenges faced by Manulife US REIT, and if the worst for the REIT is over. 

What you need to know about Manulife US REIT’s (SGX: BTOU) challenges

#1 - Manulife US REIT’s distributions have been declining

MUST has been facing steadily-increasing headwinds that have culminated in the REIT’s inability to pay out a distribution.

On the distribution per unit (DPU) front, 2019 was the last year where the REIT saw a year-on-year increase in DPU.

That year, DPU increased by 7% year on year to US$0.0596.

After 2019, the REIT suffered three consecutive years of declining DPU.

2020’s DPU, at US$0.0564, was 5.4% lower than 2019’s while 2021’s DPU slid by 5.5% year on year to US$0.0533.

Unitholders had to endure yet another year of falling DPU as 2022 came along when the REIT reported a further 10.9% year-on-year decline to US$0.0475.

The reasons were varied and included provisions made for expected credit losses from retail and food and beverage (F&B) tenants and higher rental abatements and lower rental income stemming from higher vacancies as COVID-19 hit.

2022 saw higher inflation and surging interest rates that buffeted the REIT and caused its finance costs to jump by 16.4% year on year .

Along with an increase in units arising from a private placement, DPU was once again negatively impacted. 

#2 - MUST’s portfolio valuation was cut significantly 

The trigger for the financial covenant breach came from a further decline in MUST’s portfolio valuation for 1H 2023. 

The US office REIT’s valuation slid 14.6% from US$1.91 billion as of 31 December 2022 to US$1.63 billion as of 30 June 2023.

This coincided with a steep fall in overall US office valuations of 18.4% in the second quarter of 2023, as measured by the NCREIF Property Index (shown below)

However, even before this event occurred, MUST’s portfolio valuation was steadily declining, causing its gearing ratio to rise and head precipitously towards the 50% maximum threshold set by Singapore’s central bank.

From 2020 to 2021, the total valuation of MUST’s original nine properties dipped by 0.7% year on year to US$1.98 billion. Note that MUST acquired three properties in 2021 – Tanasbourne, Diablo, and Park Place, which took its total valuation to US$2.18 billion that year.

2022 saw a sharper valuation decline as capitalisation rates headed north, with valuation coming in 10.9% lower at US$1.95 billion. Notably, just five of MUST’s 12 properties contributed to 80% of the decline.

Although MUST reported an occupancy rate of 85.1% as of 30 June 2023, the physical occupancy for its portfolio stood at just 30%, according to UOB Kay Hian.

With the valuation decline, MUST’s gearing ratio has hit 56.7%, above the 50% maximum threshold. However, this is not considered a breach because the increase was beyond management’s control.

#3 - Not the first time that a REIT has halted distributions 

Two recent examples come to mind for REITs that halted their distributions.

The first is Eagle Hospitality Trust or EHT.

EHT was listed in May 2019 and did not pay out a single distribution before it was suspended in March 2020.

This hospitality REIT was later liquidated in late 2021 with bank creditors receiving the bulk of the proceeds, leaving unitholders with a complete loss.

Another recent case involves Lippo Malls Indonesia Retail Trust or LMIRT. 

The Indonesian retail mall REIT announced the cessation of distributions to holders of its perpetual securities back in March 2023 as it sought to conserve cash.

With this pronouncement, it also triggered the stoppage of distributions to unitholders.

What would Beansprout do?

Units of the REIT have plunged nearly 91% in the past five years and the DPU over this period has been unable to mitigate the capital loss.

In August, MUST made an advance payment to its lenders to try to rectify the covenant breach described above.

However, this payment will not automatically solve the REIT’s problem as its lenders need to expressly communicate that this breach has been rectified.

With the US office market still facing tough challenges from rising interest rates, higher vacancies and lower valuations, it may be difficult for MUST to find any respite here.

With the covenant breach, MUST needs to actively negotiate with its lenders and seek a mandate from unitholders to sell assets to reduce its indebtedness.

Other strategic options to recapitalise the REIT may involve severe dilution if the manager chooses to raise funds via a highly-diluted equity fundraising exercise.

The REIT’s troubles look set to continue unless it receives a massive cash injection from its sponsor, Manulife Financial, or encounters a white knight that is willing to recapitalise the REIT.

Investors may want to consider avoiding this REIT for now as it works hard to solve its myriad of problems.

If you prefer office REITs without any US exposure, Keppel REIT has a portfolio occupancy rate that is above the sector average, and a gearing level of 39.2% as of June 2023. 

To compare and select the best office REIT for your portfolio, check out our REIT tool. 

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