Canadian financial services group Manulife began pre-marketing the initial public offering of its US office portfolio on Monday in a deal likely to raise about $440 million.
The flotation is not only shaping up to be the first ever US Reit listing in Singapore but also the first in 2015 from the S-Reit sector as a whole.
So far this year, there has just been one major equity offering from the sector – a $525 million ($390 million) accelerated placement in Keppel Infrastructure Trust, which priced in May at S$0.52 per unit. On Monday it closed at S$0.535.
Manulife US Reit is coming at a crucial time for S-Reits, which have the looming threat of rising US interest rates to contend with. Reits tend to underperform when rates rise as investors shift into other high yielding assets and the sector's top line is hit by a rising cost of capital.
Year-to-date, S-Reits have also been the second worst performer among all Asian Reits behind Japan. The sector has returned just 0.3% compared to the best performer Korean K-Reits, which are up 8.7%.
Singapore's overall performance has also been dragged down by the underperformance of commercial Reits, the same sub sector as Manulife US Reit, which are down 7.6% year-to-date. However, while institutional investors have been less active participants in S-Reits of late, private banking demand has remained strong due to the high yields on offer relative to cash benchmarks.
S-Reits currently average a forward dividend yield of 6.3%, equating to roughly 360bp over Singapore government bonds. K-Reits, by contrast, offer an average yield of 5.3%, a roughly 280bp pick up to Korean government bonds.
Manulife US Reit's management team will be hoping their deal attracts strong participation from both institutional and retail investors because it combines a high dividend yield and long debt maturity profile that will insulate the company's cost of capital from rising US interest rates.
Pre-marketing will continue through to June 26, with lodgement scheduled for June 29 and listing on July 15.
Valuation
Fair value has been estimated at $488 million to $530 million. This equates to a forward price to book range of 1.1 to 1.2 times and post tax 2016 dividend yield of 5.5% to 5.9%.
Based on the mid point of this range and accounting for a small IPO discount, the deal should have a market capitalization of about $490 million and an issue size of about $440 million. Sponsor Manulife will hold a 9.5% stake post listing.
On this basis, the deal is also likely to offer a post tax dividend yield just shy of 6%. This would place it in line with the S-Reit commercial sector average but at premium to domestically listed US Reits.
The former currently average a 2016 yield of about 6% and the latter about 4.3%.
One fund manager says: "I like what I am hearing about this Reit. It has a decent-enough yield, very good debt profile and, unlike the rest of the Singapore based S-Reits, its portfolio is freehold not leasehold."
Sources close to the deal also suggest cornerstone demand could account for up to 40% of the paper on offer, tucking away a large chunk of the deal.
Comparables
In Singapore, the key benchmarks will be other commercial Reits such as CapitaLand and Keppel Land as well as I-Reit Global, the only other Reit that offers pure non-Singapore exposure.
Both I-Reit and Manulife Global are built around freehold portfolios. CapitaLand and Keppel Land are leasehold.
However, I-Reit is exposed to the German property market and euro/Singapore dollar FX risk, while Manulife is exposed to the US property market and US/Singapore dollar risk. Asian investors are far more familiar with US cross currency risk and have therefore been consistently more comfortable with it.
Prospective Manulife US Reit shareholders will have the option of taking up their dividends in either US or Singapore dollars.
One of the other big plus points for Manulife's deal is the fact it will have the longest debt maturity profile of any of its nearest comparables. Its balance sheet has an average debt duration of 10.3 years and at a cost of 3.75%.
I-Reit has an average debt duration of four years at a cost of 2.10%, while Keppel Land and CapitaLand respectively stand at 3.4 years at 2.47% and 4.1 years at 2.40%.
Both Manulife and I-Reit are fully hedged, while Keppel Land and CapitaLand are 65% and 83% hedged.
On the minus side, Manulife US Reit will be much smaller than the domestically based Reits. It has a total net asset value (NAV) of $723 million and Net Leasable Area (NLA) of 1.465 million square feet.
Keppel Land is almost five times larger with an NAV of $5.4 billion and NLA of 3.3 million sq ft. Only I-Reit is smaller with an NAV of $341 million and NLA of 1.3 million sq ft.
Yet Manulife US Reit could rapidly scale up as it has a fairly lengthy potential acquisition pipeline of up to $13.2 billion in assets that it has the right to buy alongside its sponsor. This includes $6.2 billion of assets in Canada, $6.6 billion in the US and $300 million in Asia.
But, given that management have said they do not want to increase gearing much above the current 37.6% level, this means future deals are likely to be financed with fresh equity.
The management team stand to be incentivised with a 1% acquisition fee, 0.5% divestment fee and standard 10% cut of distributable income for every 25% increase in dividend per unit.
The dividend pay out ratio will be 100%.
Over the 2015 and 2016 financial years, revenue is forecast to grow from $68.8 million in 2015 to $69.4 million in 2016. Distributable net income is expected to rise from $27.2 million in 2015 to $28.9 million in 2016.
Manulife's Portfolio
The Reit's portfolio comprises three Grade A commercial properties in Washington DC, Los Angeles and Irvine, Orange County.
The most important in terms of NAV is Michelson in Orange County, which accounts for 43% of the total, followed by Figueroa in South Park, Los Angeles, which accounts for a further 38% and finally M Street in Washington DC, at 19%.
The average weighted lease to expiry stands at 5.1 years, with an average occupancy ratio of 97.7% and 83 tenants in total. The top 10 tenants account for 58% of income.
During roadshows, management are likely to argue their portfolio offers investors exposure to the US economy, which is outperforming many of its peers in the developed world. Most of the Reit's leases do not start to expire until 2019 and 2020.
Until then there are annual escalations in rental payments of between 2% and 3.5% for 83.1% of all the leases. This should help revenues grow by an estimated compound annual growth rate of 4.8% between the 2014 and 2016 financial years.
In terms of portfolio, the two nearest comparables in the US are probably Douglas Emmett Inc and Hudson Pacific Properties Inc.
About 89% of Douglas Emmett's portfolio is based in Los Angeles but it is much larger than Manulife with an NAV of $6 billion and NLA of 16.5 million sq ft. Its gearing is also much higher at 58.3%.
It is currently trading on a 2016 post tax adjusted dividend yield of about 4.4%.
Hudson Pacific derives about 30% of its portfolio value from Washington DC. It has an NAV of $2.8 billion and NLA of 5.7 million.
It is trading on a 2016 post tax adjusted dividend yield of about 4.2%.
IPO Syndicate
Both DBS and JP Morgan have close connections to Manulife. In April, Manulife paid DBS an initial $1.2 billion for the right to sell its insurance and wealth management products to the Singaporean bank's client base.
JP Morgan was Manulife's M&A advisor.
