Date of Report: 25 October 2024
Broker: UOB Kay Hian Private Limited
Company Overview
Keppel Pacific Oak US REIT (KORE) invests in a diversified portfolio of income-producing office real estate across growth cities in the United States that are driven by innovation and technology. It owns 13 freehold office buildings and business campuses located in eight key markets: Seattle-Bellevue/Redmond, Austin, Denver, Nashville, Houston, Dallas, Orlando, and Sacramento.
GICS Sector: Real Estate
Bloomberg Ticker: KORE SP
Market Capitalization: US$276.8 million
Shares Issued: 1,044.5 million
3-Month Average Daily Turnover: US$0.8 million
3Q24 Financial Performance
- Gross Revenue: US$37.6 million (-2.0% YoY)
- Net Property Income (NPI): US$20.1 million (-8.8% YoY)
- Adjusted NPI: US$21.2 million (-6.6% YoY)
- Distributable Income: US$11.9 million (-8.8% YoY)
The slight decline in gross revenue and NPI was due to lower portfolio occupancy, partially offset by built-in average rental escalations of 2.6% per year. Adjusted NPI excluded non-cash adjustments like straight-line rent and lease incentives.
Leasing Activity and Occupancy
- Overall Portfolio Occupancy: 88.7% (a decrease of 2.0 percentage points quarter-on-quarter)
- Physical Occupancy: Improved to 73% in 3Q24 (up by 3 percentage points QoQ)
- Leasing activities in growth cities, particularly in the Sun Belt, increased by 9.6% QoQ, indicating a strong demand for office space in these regions.
- KORE experienced a slight negative rental reversion of 1.2% for the 721,392 square feet of office space leased during 9M24, equivalent to 15% of its portfolio Net Lettable Area (NLA). The negative reversion increased to 3.5% in 3Q24, driven by lower rents at The Plaza Buildings in Bellevue.
Portfolio Management
- Occupancy Issues: Known vacates at The Plaza Buildings in Bellevue led to an 8.0 percentage point drop in occupancy to 80.5%. Management had anticipated this, and measures have been taken to attract new tenants, including building a full floor of speculative suites at the property.
- Recovery Plans: Management expects portfolio occupancy to remain around 88-89% in 4Q24. There may be a slight dip in 1Q25 due to lease expirations but a return to 88-89% occupancy is anticipated by the end of 2025.
- Rental Reversion Forecast: KORE expects rental reversions to range between -5% and +5% in 2025.
Financial Strategy
- Refinancing and Debt Management: KORE completed early refinancing and loan extensions totaling US$170 million in July and October 2024, effectively pushing most debt maturities to 2026 and beyond.
- Leverage and Debt Costs:
- Aggregate leverage stood at 42.6% as of September 2024, with an average cost of debt at 4.55% for 9M24 (slightly up from 4.47% in 1H24).
- Interest coverage ratio remains at a healthy 2.7x.
Strategic Initiatives
- Distribution Suspension: KORE will suspend distributions in 2024 and 2025 as a pre-emptive move to strengthen its balance sheet. This is expected to help fund necessary capital expenditures and manage debt levels effectively.
- Resumption of Distributions: Planned for the first half of 2026, with management looking to stabilize occupancy and potentially divest non-core assets like Iron Point in Sacramento and 1800 West Loop South in Houston to aid in deleveraging.
- Capital Expenditures: US$60 million is allocated for 2024, and US$50 million for 2025, focusing on retaining and attracting tenants.
Valuation and Recommendation
- Target Price: US$0.38 (based on Dividend Discount Model, with a cost of equity at 9.75% and a terminal growth rate of 0.5%)
- Projected 2026 Distribution Yield: 15.9%
- Price to Net Asset Value (P/NAV): 0.37x, reflecting a 63% discount to NAV per unit at US$0.71.
Key Investment Highlights
- Strong Presence in High-Growth Regions: KORE’s assets are concentrated in high-growth Sun Belt cities where leasing activities are robust, benefiting from ongoing migration trends and business expansion.
- Strategic Cost Management: By suspending distributions, KORE is preemptively managing its debt levels, enabling necessary capital investments without breaching regulatory leverage limits.
- Recovery of Leasing Activities: Physical occupancy improvement and strong demand in growth cities indicate a gradual but steady recovery for KORE’s portfolio, setting the stage for future growth.
