MANULIFE US Real Estate Investment Trust&rsquo s (MUST) market value has plunged by over a third in the past week after the office trust unexpectedly announced it had breached loan covenants, potentially impacting distributions.

 

Already one of the worst performers among Singapore-listed real estate investment trusts (Reits), MUST&rsquo s units fell further to a new closing low of US$0.105 on Tuesday (Jul 25).

 

This was a 37.9 per cent drop from the US$0.169 close on Jul 17, before the manager announced that the real estate portfolio valuation had declined by 14.6 per cent to US$1.6 billion as at Jun 30, 2023, down from US$1.9 billion six months earlier.

 

Long-suffering investors, who have seen unit prices plunge by over 80 per cent in the past year, would be wondering whether all the bad news have now been fully priced in.

 

Some may still be clinging to hopes of a future recovery in office assets, but many others would have capitulated and sold.

 

With the tough situation that MUST is facing, it may indeed be the prudent choice for investors to cut their losses and move on from the uncertainty, in favour of other opportunities.

 

Tough situation

The manager&rsquo s update to the market last week painted a tough situation that gave unitholders little to be optimistic about.

 

Portfolio valuations plunged because the &ldquo volatile macroeconomic environment&rdquo and &ldquo idiosyncratic risks&rdquo at the property level led to higher discount rates for certain properties.

 

There was also continued weakening of occupancy performance across the US office market due to a slowdown in demand and leasing activity.

 

The plunge in valuations pushed MUST&rsquo s aggregate leverage to 57 per cent, passing the 50 per cent regulatory limit.

 

Crossing this threshold may not have been unexpected, given that aggregate leverage was already at 49 per cent previously. But more concerning was the breach of financial covenants.

 

The covenants did not allow MUST&rsquo s debt to be more than six-tenths of assets on an unencumbered basis. The updated valuations meant that the trust&rsquo s unencumbered debt is now 60.2 per cent of assets.

 

The breach affects the Reit&rsquo s ability to pay out first-half distributions for the year. The moratorium on distributions could, in turn, affect the Reit&rsquo s structure, which could require more taxes to be paid.

 

To add to the woes, the breach would also result in a cross-default of interest rate swaps, and could subject the Reit to higher interest rates for its loans.

 

Analysts have slashed their target prices for the Reit following the disclosure, with DBS and UOB Kay Hian removing their &ldquo buy&rdquo calls.

 

The manager has various initiatives that it is working on to meet the Reit&rsquo s liquidity needs, but investors would have to consider whether these measures are sufficient.

 

Potential solution?

The manager said it is working with the sponsor, Manulife, on a &ldquo potential alternative method&rdquo to address the mid-to-long-term liquidity needs for the Reit.

 

Calls for more sponsor support in MUST are not new and have surfaced previously.

 

But there have been challenges in getting additional equity injections into the Reit, due to US rules that prevent any single investor from owning more than 9.8 per cent of the Reit.

 

Other possible solutions could include having the sponsor buy more properties from the Reit, or having the sponsor provide lending to pay down some debt.

 

But there are also risks of the sponsor acquiring the best assets, given that it has its own stakeholders to answer to. This could result in unitholders being stuck with a portfolio of less desirable assets that may not have strong potential for recovery in the longer term.

 

There are also concerns about whether the sponsor would act quickly enough.

 

Already, DBS analysts have said that the sponsor support at this juncture may be a case of &ldquo too little, too late&rdquo .

 

The analysts have cut the target price for MUST from US$0.24 to just US$0.10, the lowest among all analysts. DBS Group Research noted that they had previously envisioned a roadmap that had a more &ldquo urgent reaction&rdquo from the sponsor through asset sales or equity injection to prevent a breach of covenants, but they found the timing &ldquo lacking&rdquo .

 

Apart from getting additional sponsor support, liquidating more properties &ndash or even the entire portfolio &ndash may be another option for investors to get some value back.

 

The manager has said it is also exploring the disposal of assets, and said it may seek a &ldquo disposition mandate&rdquo from unitholders. This would give the Reit the flexibility to dispose of some assets as long as certain conditions are met.

 

But unitholders must also consider whether they can attract high enough bids for an asset sale to make sense.

 

The Reit&rsquo s last traded unit price of US$0.105 gives it a market cap of around US$190 million. The counter currently trades at roughly 0.25 time analysts&rsquo estimates of MUST&rsquo s revised book value of around US$0.40 per unit.

 

Based on the latest balance sheet as at end-2022, and assuming the new investment properties&rsquo valuation, Manulife US Reit would have total assets of around US$1.8 billion.

 

Meanwhile, total liabilities of roughly US$1.1 billion would give the Reit a net asset value (NAV) of around US$0.40 per unit.

 

If the Reit can be liquidated at NAV, unitholders would be able to realise the full value of the assets and enjoy a sizeable upside from the current levels.

 

But selling assets at their book value may be a tough ask in the current market where interest rates are high, and US office properties are struggling.

 

Back-of-the-envelope calculations show that if the investment properties are sold at a 30 per cent discount to their current valuation, investors might not be able to get much more than the current unit price in return.

 

The manager noted in its update last week that US office valuations remain under pressure and are likely to decline further in 2023.

 

The latest financial statements from the Reit, which would be released on Aug 14, will provide further insight into the balance sheet for investors&rsquo consideration.

 

Investors who remain hopeful for future recovery should also keep an eye on whether there are clearer signs of support coming from the sponsor to help the Reit tide through the current crisis.

 

But they should also consider whether any potential upside from recovery is worth the uncertainty of staying invested.