On 18 April 2023, Keppel Pacific Oak US REIT (“KORE”) have announced their 2023 first quarter business update. The fundamentals of KORE have continued to deteriorate this quarter and, as expected, the share price decreased since my previous article. The overall market sentiments for US Office REITs is currently still negative, and KORE remains the REIT that have the highest risk to reward ratio that I am holding and covering in my blog with its direct and concentrated exposure to the US office space.
I would like to highlight that the total debt was unchanged as at 31 March 2023 compared to 31 December 2022. This meant to say that there were no repayments during this quarter and accordingly, no new debt were taken as seen by the decease in Debt Maturity Profile of approximately 1 quarter. Although the gearing remains relatively neutral, having no principal repayments for loans for a quarter is considered unusual. This may be an indication of issues and we shall see if there are any updates in the upcoming half year announcement.
Background
KORE is a distinctive office REIT listed on the main board of the Singapore Exchange Securities Trading Limited (“SGX-ST”) on 9 November 2017.
KORE’s leverages its focus on the fast-growing technology, advertising, media and information (“TAMI”), as well as medical and healthcare sectors across key growth markets in the United States (“US”), and aims to be the first choice US office S-REIT providing sustainable distributions and strong total returns for Unitholders.
KORE invests in a diversified portfolio of income-producing commercial assets and real estate-related assets in key growth markets characterised by positive economic and office fundamentals that generally outpace the US national average and the average of gateway cities. These markets include the Super Sun Belt and 18-Hour Cities, which have and continue to see an accelerated influx of talent as part of The Great American Move.
KORE is managed by Keppel Pacific Oak US REIT Management Pte. Ltd., which is jointly owned by two Sponsors, Keppel Capital and KORE Pacific Advisors (“KPA”).
Key Metrics
Distribution Per Unit (“DPU”)
| Metrics | Current | Previous |
|---|---|---|
| Distribution Per Unit | No Info | -8.5% |
Based on the announcement on 18 April 2023, DPU was not included in the business update for the first quarter of 2023.
However, they have provided that the income available for distribution have decreased by 21.2% this quarter when compared to the same period in the prior year. Considering the decrease for 31 December 2022 and 31 March 2023, this metric is Unfavorable.
Occupancy
| Metrics | Current | Previous |
|---|---|---|
| Occupancy | 91.9% | 92.6% |
Occupancy rate as at 31 March 2023 stands at 91.9%. This is Unfavorable as it is below my expected healthy occupancy rate of 95% and KORE have not been able to fully utilize their assets.
This is part of the high risk to reward ratio. Unlike Singapore, the US have embraced remote and hybrid work till date, with the larger companies having terminated their leases. US office buildings are unlikely to regain their peak pre-pandemic values until at least 2040 as demand for desk space weakens, according to a forecast by Capital Economics.
Website: US office owners get dire warning: Rebound unlikely before 2040
This does not however make excuses for KORE’s 91.9% to be considered favorable. Overall it will still have DPU impact should the environment worsen further. KORE has a Weighted Average Lease Expiry (“WALE”) of 3.3 years which should provide sufficient income visibility. However, it is still possible for leases to be early terminated. For investors that are risk adverse, it may be worth considering other REITs with stable occupancies.
Gearing ratio
| Metrics | Current | Previous |
|---|---|---|
| Gearing Ratio | 38.7% | 38.2% |
Gearing ratio stands at 38.7% as at 31 March 2023. This to me is Neutral, as although there is sufficient buffer from the MAS limit of 50%, the gearing have increased and may present an issue should there be any valuation write-downs which I am expecting in the short-term. A larger buffer may be needed to prevent any force selling of assets and KORE can also take advantage to raise debt to fund acquisitions if opportunities arose.
Interest coverage
| Metrics | Current | Previous |
|---|---|---|
| Interest Coverage | 3.6x | 4.0x |
The interest coverage stands at 3.6 times as at 31 March 2023. The metric is Unfavorable as the interest coverage is lower than my preference of 5.0 times and seems to be worsening. This is a concern as interest rates continue to rise as the world looks to tackle inflation. The Federal Reserve on 22 June 2023 have hinted to continue hiking interest rates, after their last rate hike in 3 May 2023 have brough the interest rates to a range between 5.00% and 5.25%.
Website: US Fed official says more rate hikes necessary
As the interest rate may potentially increase further, KORE may be subjected to significant change in their cost of debt in the near future. In their presentation they have mentioned that 77.9% of their debt is also on fixed rates.
I have thus performed a sensitivity analysis using the information as at 31 March 2023:
| Description | Amount (SGD’000) |
|---|---|
| Total Debt | $580,200 |
| Debt Not Hedged (%) | 22.1% |
| Debt at Floating Rate Exposed | $128,224 |
| Distributable Income FY2022 | $60,578 |
Interest rate sensitivity analysis as below:
| Change in Interest Rates | Decrease in Distributable Income (SGD’000) | Change as % of FY2022 Distribution |
|---|---|---|
| + 50 bps | -$641 | -1.1% |
| + 100 bps | -$1,282 | -2.1% |
| + 150 bps | -$1,923 | -3.2% |
| + 200 bps | -$2,564 | -4.2% |
| + 250 bps | -$3,206 | -5.3% |
| + 300 bps | -$3,847 | -6.4% |
Do note the above is my estimation which may be different from management’s estimation. Nonetheless, if the interest rates were to increase by the basis points above, KORE may experience a fall in DPU accordingly.
Debt maturity profile
| Metrics | Current | Previous |
|---|---|---|
| Debt Maturity Profile | 3.4 years | 3.6 years |
Weighted average term to maturity of their debt stands at 3.4 years as at 31 March 2023. This is Favorable and it allows them sufficient time to refinance their debts as they fall due.
Price to Book Ratio
| Metrics | Current | Previous |
|---|---|---|
| Price to Book Ratio | 0.43 | 0.48 |
Based on the announcement on 18 April 2023, net asset value (“NAV”) was not included in the business update for the first quarter of 2023.
The Price to Book (“P/B”) ratio currently stands at 0.43. This is computed using the closing share price of USD0.345 on 7 July 2023 and the net asset value per share of USD0.810 as at 31 December 2022.
The metric is Favorable as we are paying below book value for its assets. This provides sufficient buffer should there be a significant write-down of valuation for its assets. However, there is a reason for it to be traded at this P/B ratio and is covered under the “Key things to note” section.
Dividend yield
| Year | Yield | Total |
|---|---|---|
| 2023 | 8.06% | USD 0.028 |
| 2022 | 16.12% | USD 0.056 |
| 2021 | 20.09% | USD 0.069 |
| 2020 | 14.55% | USD 0.050 |
| 2019 | 14.35% | USD 0.050 |
The current payout of USD0.028 is in line with the payout for 2022. Thus if extrapolated for the full calendar year 2023, the expected dividend payout would be USD0.056 per share. With a closing share price of USD0.345 as at 7 July 2023, this translates to a dividend yield of 16.12%. For my benchmark, a general reasonable range would be around an average of 5.5% to 6.5% in the current environment. KORE’s dividend yield is way above my benchmark.
Website: Reasonable Dividend Yield 2023Q3
The current macro-environment suggest that the US office REITs may be facing significant downward pressure in the short-term which is covered under the “Key things to note” section. As part of the risk to reward ratio assessment, I evaluated a scenario where the valuations and annualized dividend yield were to be halved to 8.06%. As the halved dividend yield is still above my benchmark, the dividend yield metric is Favorable.
Do note that the halving of dividend yield is my expectation should a worst case scenario occur. Management have taken steps to ensure that it does not happen. If the dividend payout is able to be maintained, the dividend yield would be attractive for the long term.
Other metrics
Tenant profile
KORE has an enlarged portfolio covering multiple trade sectors. The high quality and diverse tenant base provides resilience to the KORE portfolio across challenging events. The top-10 tenants accounted for only 23.8% of KORE’s portfolio with no single tenant accounting for more than 3.6% during the period, providing income diversity to the portfolio. Furthermore the WALE of the top 10 tenants is 4.4 years, which provides a strong income visibility as the US rides out the uncertainty.
Key things to note
Risk of property valuation write-down
KORE have surprised me with showing that their office valuations remain relatively unchanged as at 31 December 2022 despite the fall in DPU. As valuations are done on an annual basis, it is unlikely to have any major impact until the end of 2023.
Nonetheless, the US office space have been on a downturn the last few months with occupancy decreasing. As the world continues to increase interest rates to combat inflation, businesses are starting to feel the impact as enter 2023, with sources for cheap funding drying up.
United States office buildings are unlikely to regain their peak pre-pandemic values until at least 2040 as demand for desk space weakens, according to a forecast by Capital Economics. Values are expected to plunge 35.0% from the peak by the end of 2025 and take an additional 15 years or more to recover as hybrid and remote work reshape real estate.
Website: US office owners get dire warning: Rebound unlikely before 2040
While we may not necessary see a Global Financial Crisis (“GFC”) level kind of crash, in general there are estimates that property prices could drop 20%-30% in 2023, before seeing an uneven recovery after that.
Should the property valuation decrease by 30%, this will bring their total invest properties value as at 31 December 2022 to USD996 million and total assets to USD1,092 million. Assuming the borrowings remain unchanged, this will have implications as the gearing ratio of KORE will increase to approximately 53.1% from the 38.2% as at 31 December 2022. This will breach the MAS limit and KORE will be forced to raise funding via equity or sale of properties to lower their gearing. Both options may not be desirable given that the share price is trading at a significant discount of its book value or KORE may have to realized losses if they are unable to dispose of their assets at book value.
This is coupled with the fact that this is a foreign investment REIT that is listed on SGX, where these kinds of REIT profile are less appealing to Singapore investors.
Summary
| Metrics | Financials | Rating |
|---|---|---|
| Distribution Per Unit | -8.5% | Unfavorable |
| Occupancy | 91.9% | Unfavorable |
| Gearing Ratio | 38.7% | Neutral |
| Interest Coverage | 3.6x | Unfavorable |
| Debt Maturity Profile | 3.4 years | Favorable |
| Price to Book Ratio | 0.43 | Favorable |
| Overall | | Neutral |
Overall, the metrics indicate that it is neutral to invest in KORE. Since my last article, KORE have continued to see their share price fall by 10.4%, and the recent market conditions present opportunities for entry as the share price continues to face downward pressure and trade at a significant discount from its book value.
Despite the relatively stable results, investors need to take note that of their risk appetite as KORE may not necessary be worth the risk. Especially as safe assets have seen their yield rise considerably with rising interest rates, the appeal of KORE may take a turn for the worse and further downside may happen.
Disclaimer: Not financial advice. All data and information provided on this site is for informational purposes only.
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