How will Manulife US Real Estate Investment Trust’s Latest Acquisition and Preferential Offering Affect Unitholders?

Editor’s note: A previous version of this article had erroneously stated that Manulife US REIT’s latest acquisition is DPU-accretive. The error has been corrected, and the conclusion of this article has also been changed to reflect the correction. The Motley Fool Singapore regrets the error.

Manulife US Real Estate Investment Trust (SGX: BTOU) is the first pure-play United States office REIT listed in Singapore’s stock market. It currently has a portfolio of five properties located in five cities across the US.

In April this year, the REIT proposed the acquisition of two new properties in the US – one in Washington, and another in Atlanta – and then followed up with the announcement of a preferential offering on 16 May. The preferential offering’s purpose is to partially fund its proposed acquisition.

Here is what existing and potential investors in Manulife US REIT need to know about the acquisition and preferential offering.

Quality assets

The two target properties are 1750 Pennsylvania Avenue (Penn), and Phipps Tower, Atlanta (Phipps). Both buildings are effectively free hold, and have a combined net lettable area (NLA) of around 753,000 square feet.

Let’s Penn down the details

Penn is considered a Class A office building, and is sitting on highly coveted land, considering that it is located just a block away from the Whitehouse. As of 31 March 2018, the property had an average independent valuation of US$185 million. Manulife US REIT has agreed upon a purchase price of US$182 million, which is a 1.6% discount.

Penn has a high occupancy rate of 97.2%, with the U.S. Department Of Treasury its main tenant. The Treasury contributes 41.7% of the property’s gross rental income, and will provide stability to the rental stream.

Another positive is that over the last six years, US$6.0million in asset enhancements have been invested in Penn. The building’s current leases also have built-in rental escalation terms, and have a long weighted average lease expiry (WALE) of 6.8 years. Furthermore, Penn currently has an average passing rent that is below the market rate; this gives Manulife US REIT room to increase the property’s rent when the existing leases expire.

More about Phipps

A 19-storey office building, Phipps also has an unofficial “trophy” status which is reserved for real estate in the top 2% of properties in a given subcategory. The ranking is based on a range of factors including yield, architecture, and/or historical value. Phipps was valued at US$209.2 million, but its agreed-upon purchase price is US$205.0 million, which represents a 2% discount.

The property currently has a 97.3% occupancy rate and a long WALE of 10.0 years. More than 90% of its leases (by both gross rental income and NLA) only expire in 2023 and beyond. Similar to Penn, there are built-in rental escalation terms in the majority of the existing leases in Phipps. This will again provide a stable and consistent rental income stream.

Funding the acquisition

The acquisition will be funded by a mix of debt and equity funding. The REIT also said that its Manager’s acquisition fee will be paid in the form of units of itself.

Two weeks ago on 16 May, Manulife US REIT announced a 22-for-100 preferential offering to raise funds for the acquisition. There will be a total of around 228 million new units offered at an issue price of US$0.865 per new unit. This represents a 7.9% discount to the volume weighted average unit price of US$0.939 on 15 May, and will raise gross proceeds of US$197.2 million for the REIT.

How will it affect the REIT’s gearing

Manulife US REIT’s Manager has announced that US$6 million of the gross proceeds raised from the preferential offering will be used to pay the associated-fees. The rest of the sum will be used to fund the acquisition of Penn and Phipps. Based on this, we can calculate that another US$196 million will need to be borrowed by the REIT to fund the purchase.

As of 31 March 2018, Manulife US REIT had total assets valued at US$1.36 billion, and borrowings of US$458.6 million. The acquisition will increase the REIT’s asset base to approximately US$1.75 billion while its debt – based on the expected sum of money needed to be borrowed – should increase to US$654.6 million. This will put the REIT’s gearing at 37.4%, an increase from the current level of 34.1%, but still well below the regulatory limit of 45%.

How will it affect the REIT’s distribution per unit

Perhaps the key question to most unitholders is how the acquisition of the two US properties will affect the REIT’s distributions.

Below is a table showing the pro forma financial effects of the proposed acquisition on DPU and NAV.

Source: Manulife US REIT press release

As you can see, despite an increase in distributable income, the distribution per unit declines from 5.77 US cents to 5.71 US cents. This is because of the enlarged unit base resulting from the preferential offering.

The Foolish bottom line

Manulife US REIT’s proposed acquisition of Penn and Phipps has both good and bad aspects.

Investors should be pleased that the properties in question are of high quality, and will expand the REIT’s geographical footprint. The properties also possess favourable lease contracts with built in-rental escalation terms. These contracts give the REIT visible organic income growth potential for the next few years. Moreover, the fact that investors can participate in the preferential offering at a discount to the market price should provide additional upside.

On the other side of the coin, investors should be warned that the enlarged unit base of the REIT – as a result of the preferential offering – will have a negative impact on unitholders’ distribution per unit. This might, in turn, put downward pressure on the REIT’s unit price in the future.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.