Would I Buy US Office Singapore REITs at 24-40% Dividend Yield?

We've seen an unfolding of a huge shake-up in US offices. Would these Singapore REITs be worth looking at today?

US office Singapore REITs are trading at jaw-dropping dividend yields. I mean, it’s one thing to be attracted to a 7-8% dividend yield across Singapore REITs. 

But man, Prime US REIT today trades at 44% yield, while Keppel Pacific Oak US REIT trades at 24% yield. 

 

Are their dividend yields worth the risk?

I was also thinking if it’s worth adding to my Diligence Stock Watchlist

Let’s find out. 

What happened so far?

The thing is, COVID-19 has forced many people wanting to work from home in the US.  This is especially so with bigger cities like New York, Los Angeles and San Francisco where it’s harder to travel to work because of frequent, heavy traffic. As a result, US office — or US  commercial real estate — vacancies have soared to about 18% of total office spaces. 

Source: Moody’s 

This resulted in more and more companies reducing their physical leases, which have pressured rental rates. 

For instance, Prime US REIT’s physical occupancy only stood at 58%. In fact, more than half of this Singapore REIT’s assets had far lower physical occupancy, which could be a critical warning that these tenants could further lower than physical leases, or simply find somewhere else cheaper.

Now, the problem with US offices – or US commercial real estate – started when the Fed decided to slam the brakes on interest rates last year, having brought the last 15 year cycle of “easy money” to a complete halt. 

The thing is, unlike the US housing market – where you could lock in 30-year fixed rate mortgages – it’s trickier for US offices because borrowing costs move up and down for landlords taking up office mortgages. 

This creates a bad timing for US offices. 

On one hand, these offices have suffered lower profits from lower occupancy. On the other, they also have to deal with higher borrowing costs that could further squeeze profit margins. What’s more, higher interest rates have also forced property valuations to drop. 

This bad timing has caused Manulife US REIT to stop its distributions, while Keppel Pacific Oak REIT’s DPU fell 12.6% and Prime US REITs’ DPU fell 30%.

Are US Office Singapore REIT high gearing a risk?

But I’m not so concerned with gearing ratio. I expect Singapore REITs to comfortably refinance their debt. And I’m sure MAS is trying to help these US office Singapore REITs in some ways, rather than leaving them to struggle. 

What’s concerning though, is the creeping borrowing costs. You see, while Fed has decided to keep interest rates on hold, many of these Singapore REITs have interest rate swaps, or hedges, that will expire over the next few years. Years back, these interest rate swaps were fixed at a much cheaper costs. 

However, in a higher interest rate environment, these Singapore REITs could face higher financing costs as they renew their interest rate swaps.

A closer look at Prime US REIT shows its interest rate management is in a precarious position. While one of its major properties has been hedged till at least 2029, it has interest rate swaps that expire in 2024 and 2026. Which means, when these swaps expire, it needs to be renewed. And get this — probably at a far higher interest rate now since borrowing costs have gone up.

This could further plunge its distributions, lowering DPU by a substantial amount. 

That’s the bad news. 

What I still like about US Office Singapore REITs

 

The good news is, when I looked closer, these are high-quality assets. 

All three have high-quality assets that are actually higher than US office average occupancy rates. I mean, there’s really nothing shady with these properties. 

 

Management probably hadn’t foreseen the wreckage it could potentially cause when the Fed decided to end its narrative of easy money. Overnight, that caused a huge wreck across US offices. And because of that, overnight, the whole narrative just swings into a bad situation. 

 

Which means, actually these REITRs’ occupancy rate isn’t as bad as it’s made out to be. Prime US REIT’s occupancy stands at 86%, Keppel Oak REIT stands at 90%. And even Manulife US REIT stands at 86%. 

Comparing across the entire US office sector, these occupancy rates are considered pretty solid. In my view, I think these assets do fetch a pretty strong competitive advantage compared to most offices in the US. And today, US Class A occupancy rate is about 79%.

Would I buy US Office Singapore REITs today? 

It’s a tough call. First things first. This is not your typical dividend play. I expect little consistent dividend pay-out from here. I’ve wrote about US office REITs previously here. But it seems like things have changed. And what’s more, with the unfolding a slow-motion crisis in US offices, it’s better to give US office REITs a miss. 

Having said that, these Singapore REITs are probably more suited for investors looking at special situations. This is because with Prime US REIT, Keppel Oak US REIT trading at a deep discount to their net asset value (NAV), any positive news could send these shares recovering quickly. It’s also crucial to note you need holding power. While these REITs own pretty high-quality assets, it probably will take a while for things to get better. 

Sometimes, investing can be simple. 

Willie Keng, CFA

Founder, Dividend Titan

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