UOB Kay Hian initiates Prime US REIT at 'buy' with TP of 78 US cents

Felicia Tan
3-min read

At its current share price levels, the REIT’s valuations are “bombed-out”, says UOB Kay Hian's Jonathan Koh.

UOB Kay Hian analyst Jonathan Koh has initiated coverage on Prime US REIT with a “buy” call and a target price of 78 US cents ($1.03).

At its current share price levels, the REIT’s valuations are “bombed-out”. Units in Prime US REIT corrected by some 40% in the 2H2022 amid the rising interest rates. Units in Prime US REIT closed at 41.5 US cents at the close of Jan 17, which provides a distribution yield of 15.2% and yield spread of 11.7% for the FY2023, notes Koh.

With its P/NAV at 0.56x, Koh adds that the stock is oversold and that its “current weakness presents a good opportunity to accumulate the stock”.

In his report dated Jan 18, Koh sees several positives that may lead to a re-rating in the REIT’s unit price.

Prime US REIT, which has a portfolio of 14 Class A freehold office properties in 13 key office markets in the US, looks set to benefit from the “flight to quality” trend despite the gloom in the US market seen in the second half of 2022.

“Class A offices with amenities are well sought after to attract employees back to work from the office. Demand is skewed towards high-quality Class A office space. According to Cushman & Wakefield, Class A offices outperform in net absorption. Premium in rents commanded by newer Class A office buildings have also doubled during the Covid-19 pandemic,” Koh writes.

In addition, some of the REIT’s key tenants are blue-chip companies with strong credit standing. These include names like Charter Communications, Goldman Sachs, Sodexo, Dexcom, Wells Fargo and Bank of America, which are among the REIT’s top 10 tenants.

“[The] weighted average lease expiry (WALE) for its top 10 tenants is healthy at 4.6 years. Some 73% of tenants are in the established and growth (STEM/TAMI) sectors,” he adds.

STEM stands for science, technology, engineering and math while TAMI stands for technology, advertising, media and information.

In addition to its quality portfolio of offices, Prime US REIT has a sizeable exposure to the 18-hour and Super Sun Belt cities, which attract an influx of companies and people. These high-growth cities have low or no state-level taxes, a highly educated workforce generated by renowned local universities, rich amenities and good infrastructure, says Koh.

Plus, the REIT has room to consistently generate positive rental reversion.

“Prime US REIT has generated positive rental reversion consecutively for the past 10 quarters. On a portfolio basis, in-place passing rents were 6.7% below asking rents in 4QFY2022,” notes Koh.

“Within its portfolio, Park Tower at Sacramento, Sorrento Towers at San Diego, Crosspoint at Philadelphia and Tower 909 at Irving have the potential to provide strong positive rental reversion of 11.2%, 21.3%, 17.7% and 13.0% respectively in 4QFY2022,” he adds.

Driven by higher interest rates, Koh expects the REIT’s cap rate to increase by 50 basis points (bps) to 6.8%. On this, he estimates the REIT to see a US$124.8 million drop in the fair value of its investment properties, which will cause its aggregate leverage to drop by 3.4 percentage points to 42.1%, below the 50% limit.

The REIT’s net asset value (NAV) per unit may also drop by 13% to 75 US cents.

To Koh, Prime US REIT’s exposure to the fluctuation in the US’s interest rates as “prudently hedged”.

“Some 83% of Prime US REIT’s borrowings [are] on fixed rates or [are] hedged to fixed rates. About 66% of its borrowings [are] fixed or hedged till mid-2026. It does not have any refinancing obligations till Jul 2024,” he notes.

As at 4.35pm, units in Prime US REIT are trading 1.5 US cents higher or 3.61% up at 43 cents.

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