SECURITIES Investors Association (Singapore) has posed a string of questions to the manager of Manulife US Real Estate Investment Trust (MUST) : BTOU +22.03% on the plans to raise funds through a mix of asset dispositions and a sponsor-lender loan.

 

The investor watchdog met the sponsor, the senior management of the Reit&rsquo s manager, and about 300 unitholders on a virtual platform on Wednesday (Dec 6) to better understand the fund-raising proposal announced on Nov 29.

 

Following the discussion, the investor watchdog, known as Sias in short, sent the Reit manager&rsquo s board and chief executive officer (CEO) a list of 13 questions on the proposed recapitalisation and sponsor-lender loan, as well as on a recent acquisition. Sias also asked whether the interests of the sponsor and manager were aligned with those of the unitholders.

 

Sias queried MUST&rsquo s manager why the United States office-focused Reit was paying the sponsor an exit premium. &ldquo An &lsquo exit premium&rsquo is unheard of in this part of the world,&rdquo said Sias CEO David Gerald.

 

Under the arrangement, the sponsor is to grant a six-year, US$137 million loan to MUST at an interest rate of 7.25 per cent, paid quarterly, with an exit premium of 21.16 per cent on maturity. This translates to an effective interest rate of 10 per cent per annum.

 

Sias also asked the manager about the negotiations over the interest rate and exit premium, as it was concerned about a conflict of interest.

 

Gerald asked: &ldquo How did the board ensure that the interests of unitholders are taken care of, and in fact, prioritised over those of the Reit manager and the sponsor? Has the manager prioritised the interests of unitholders over those of the Reit manager and the sponsor?&rdquo

 

MUST&rsquo s manager had earlier said that the 10 per cent effective interest for the sponsor&rsquo s loan has been deemed by an independent financial adviser to be on normal commercial terms. There is currently no financing available for the US office market.

 

Sias wanted to know whether the Reit should take out a rights issue instead to raise funds it also asked what the challenges and concerns are for doing so, including whether the potential risk of the manager losing control of the Reit was one of them.

 

On the concerns about interest alignment, the investor watchdog asked whether unitholders should continue to trust the manager when there appears to be &ldquo too much&rdquo misalignment.

 

Gerald also quizzed the manager and sponsor: &ldquo Are unitholders asked to sacrifice while the manager and the sponsor maintain status quo, or in fact, profit from this situation? What is the manager giving up? What is the sponsor giving up?&rdquo

 

Unitholders would also not be receiving distributions before December 2025, unless the Reit meets &ldquo early reinstatement conditions&rdquo , which are similar to the regulatory leverage limits in Singapore.

 

Sias also pressed for accountability for the loss of US$7.3 million from the proposed divestment of Park Place, MUST&rsquo s property in Arizona, to its sponsor. It noted that the property had been acquired only at the end of 2021, for US$106 million, on the prospect of fortifying the portfolio and it being an accretive move.

 

The investor watchdog asked whether the manager had under-estimated the extent of the Reit&rsquo s problem, as well as grossly misread the market.

 

Sias was concerned as well about the significant risk of the proposed recapitalisation plan having been leaked, possibly creating a false market and paving the way for insider trading.

 

It also questioned the roles that the directors, particularly the independent directors, played in drafting the proposed recapitalisation plan, which aims to remedy a breach in its financial covenants.

 

The plan, which requires shareholders to vote on three inter-conditional resolutions at an upcoming extraordinary general meeting (EGM), seeks to &ldquo revitalise&rdquo the Reit, the sale of assets and realisation of value.

 

MUST breached its financial covenants in July, after its portfolio valuations fell 14.6 per cent, affecting its ability to pay out distributions. The Reit&rsquo s proportion of unencumbered debt to unencumbered assets exceeded the 60 per cent threshold its aggregate leverage also crossed the 50 per cent regulatory gearing limit.

 

The EGM seeking unitholders&rsquo approval for the divestment of Park Place, the sponsor loan, and the disposition mandate will take place on Dec 14.

A LIFELINE was thrown to Manulife US Real Estate Investment Trust (MUST) last week, some four months after the Reit breached financial covenants.

 

The rescue package &ndash in the form of a three-part recapitalisation plan that entails selling assets and taking a loan from its sponsor &ndash provides MUST with a longer timeline to navigate out of its current troubles.

 

It is logical for unitholders to vote in favour of the recapitalisation plan at the upcoming extraordinary general meeting (EGM), but investors are still caught between two unpalatable situations.

 

The recapitalisation plan certainly beats a disorderly liquidation of the portfolio in a weak US office market, which could leave unitholders with nothing. But equity holders still face uncertainty over the value that could be realised in the longer term.

 

For most Reit investors who typically seek regular dividend income, a key question would be whether the risk is worth the reward, in view of other potentially attractive opportunities also available in the market.

 

Getting stuck

 

MUST&rsquo s current woes started in July, when its portfolio valuations fell 14.6 per cent. This caused the Reit to breach its existing financial covenants, and affected its ability to pay out distributions.

 

The Reit&rsquo s proportion of unencumbered debt to unencumbered assets exceeded the 60 per cent threshold, and its aggregate leverage crossed the 50 per cent regulatory gearing limit.

 

This left the Reit in a tough situation with few good options remaining. But the recapitalisation plan announced last week provided a glimmer of hope.

 

The Reit is receiving financing from its sponsor &ndash with US$137 million in loans &ndash at a time when few lenders are willing to extend credit. The loan, together with the asset sale of Park Place in Arizona to the sponsor, and utilisation of some of US$50 million in MUST&rsquo s cash holdings, would help pay down the US$285 million in outstanding debt on a pari passu basis, reducing lenders&rsquo exposure.

 

The deal also buys the Reit time, as its weighted average debt maturity is now at 3.7 years, up from 2.3 years, with the earliest expiry in 2025. This gives the Reit a 19-month runway to execute asset dispositions.

 

Compared to a disorderly liquidation in the current unfavourable US office market, the recap plan appears sound.

 

MUST does not have to immediately face the risk of lenders accelerating the payment of its US$1 billion in loans, which could result in liquidation of the portfolio at distressed prices.

 

But unitholders were still unenthusiastic. The counter plunged by almost 43 per cent the following trading day to US$0.052.

 

Selling action was also heavy, with over 100 million units being traded this was more than 10 times the average daily volume in the past year.

 

The counter rallied in November, as investors anticipated &ldquo a holistic sponsor package that would address MUST&rsquo s longer-term liquidity needs and provide financial flexibility&rdquo . But clearly, the deal fell short of expectations.

 

Uncertainties

 

A key issue for investors was likely the significant uncertainty over the value that could eventually be realised.

 

For one, half-yearly distributions remain suspended until December 2025, unless the Reit achieves &ldquo early reinstatement conditions&rdquo , which are similar to the regulatory leverage limits in Singapore.

 

Meanwhile, the Reit has conducted a portfolio analysis, and is seeking to sell off less desirable &ldquo Tranche 1&rdquo assets that have higher occupancy risks and capital expenditure requirements in return for lower total potential return.

 

While the strategy is sound, the Reit is selling off such assets in a weak US office market, meaning that they are probably less attractive to many buyers.

 

MUST has noted that a key issue is that debt markets currently lack liquidity, and buyers who have cash now are currently bargain hunting. Buying more time for the normalisation of debt markets could result in a normalised transaction market.

 

But there are still execution risks, given that the US office market is facing structural challenges from changing work patterns post-pandemic.

 

The sponsor also has not acquired an asset from Tranche 1. Instead, Park Place would have been ranked in a higher tranche, which has lower occupancy risks, and better return potential.

 

It was noted that the sponsor operates in a heavily regulated industry, with its own shareholders to answer to. Indeed, it may not be realistic to expect the sponsor to table a rescue deal that would fully bail out unitholders.

 

But it is likely that investors were not expecting the sponsor&rsquo s support to come at such a high price. The sponsor&rsquo s loan extended to MUST comes at an effective interest rate of 10 per cent per annum.

 

While this has been assessed to be on &ldquo normal commercial terms&rdquo by the independent financial adviser, unitholders would probably have preferred that the sponsor support showed more skin in the game.

 

Debt investments at a fixed rate of return provide greater certainty compared to equity holders, who face halted distributions.

 

In the longer term, investors could also face further equity fundraising rounds in future.

 

The recapitalisation plan gives MUST a chance to eventually recover, but the uncertainty over the next two years makes it a tough proposition for income-seeking Reit investors to stay on.

 

Dozens of other Reits in the Singapore market are also trading at discounted valuations amid the high interest rate environment.

 

Bloomberg data shows that the sector has an average price-to-book ratio of 0.8, with a median trailing distribution yield of nearly 7 per cent. Many counters also provide opportunities for upside, based on analysts&rsquo target prices, without this much uncertainty.

 

Analysts have expressed a preference for counters in the retail and hospitality sub-sectors. Switching to counters with strong balance sheets and supportive sponsors may prove to be a more rewarding play in the longer term.