KORE' s manager expands on rationale to suspend distributions, answers awkward questions during briefing.

In an update to investors on Feb 15, UOB Kay Hian expressed shock at the suspension of distributions by Keppel Pacific Oak US REIT&rsquo s (KORE) board and management.   &rdquo Investors are rightfully shocked as aggregate leverage of 43.2% as of Dec 23 remains within MAS&rsquo regulatory limit of 50%,&rdquo the update says.

 

During a results briefing on Feb 15, (which was originally scheduled for Jan 31), one or two analysts also expressed surprise, and perhaps even shock.

 

As an example, CapitaLand Ascendas REIT A17U - &rsquo s detailed valuations in FY2023, released on Feb 1 indicated that its US portfolio, which comprises campus business, medtech and tech parks (like KORE&rsquo s), and logistics warehouses, had declined by 19% y-o-y.

 

Against this background, KORE&rsquo s 6.8% decline looked somewhat mild. As David Snyder, CEO of KORE&rsquo s manager puts it, the focus is on maintaining the valuation of the properties by pro-active leasing, keeping occupancy high, and by spending on tenant incentives and AEI. 

 

In a nutshell, KORE is suspending distributions per unit (DPU) for distributable income (DI) in 2HFY2023, FY2024 and FY2025 to conserve capital for capex on tenant incentives and AEI. This is possible because the valuation decline caused net loss of US$67.7 million in FY2023.

 

Also, as stated in the statement issued by KORE on Feb 15, banks' required loan-to-value is 45% for US commercial property. DI will still be reported, but it will be used for capex. 

 

&ldquo In relation to the suspension of distributions, the drop in valuation of KORE&rsquo s assets announced on 30 January 2024 creates a loss situation in which any distribution would be in excess of the combination of profits and the US$75 million loans due for refinancing by 4Q2024,&rdquo the KORE statement explains, and as allowed by the Code on Collective Investment Schemes and the trust deed. 

 

The Code on Collective Investment Schemes (Property Funds Appendix) states that if &ldquo the manager declares a distribution that is in excess of profits, the manager should certify, in consultation with the trustee, that it is satisfied on reasonable grounds that, immediately after making the distribution, the property fund will be able to fulfil, from the deposited property of the property fund, the liabilities of the property fund as they fall due" . 

 

Based on the distributable income reported in FY2023 of US$52 million, withholding distributions for 2H2023, FY2024 and FY2025 will help conserve around US$130 million based the REIT&rsquo s current cost of debt of 4.12%. The outlook for all-in cost of debt for this year is around 4.3% to 4.4%.

 

&ldquo Based on certain expectations in floating rate changes, eg 50-75 bps drop in floating rates in 2024 and assuming early refinancing of loans due in 2025 baked into budget assumptions, the all-in cost of debt is likely to be around 4.3%-4.4%,&rdquo KORE&rsquo s manager says.

 

Among the interesting questions and answers worth highlighting are those around equity fund raising (EFR), distribution reinvestment plan (DRP), management fees (indeed), and sponsor support.

 

On EFR, Snyder says there won&rsquo t be further fund raising. &ldquo What we are trying to avoid is coming back to unitholders twice. Our board deliberated long and hard about the best decision to make. [Withholding distributions] was the only option we found where we think it is likely we don' t have to come back to unitholders. We expect that withholding distributions should be sufficient to cover capital needs for 2024 and 2025 without additional EFR,&rdquo Snyder says.

 

On the other hand, DRP, that many REITs, including most recently, CapitaLand Integrated Commercial Trust C38U - , C38U - , have implemented, was looked at but viewed as not feasible. All the unitholders would have had to subscribe to the DRP in order to conserve the some US$50 million of distributable income a year.

 

On a question whether the manager could reduce its management fees, Snyder accepted that is a &ldquo natural question&rdquo .

 

&ldquo We' re not considering cutting the management fee, the management fee is what enables the manager to pay the team, have a team in place to do all of this work. Our performance has been quite strong. The unitholders are paying a fee and actually getting a result for that fee. We' re not facing an operational crisis. We' re not really facing a complete liquidity crisis,&rdquo he says.

 

&ldquo It is purely a capital side issue that has been created by the fact that, for reasons that don' t always make sense to us, our stock has traded well below the value it should be trading at, at massive discounts to the NAV.&rdquo  

 

In the event of an unlikely scenario that banks want to be more cautious on lending to KORE, can investors be assured that Keppel is behind KORE? Here, the answer is ambiguous.    

 

&ldquo Keppel is our sponsor, I cannot speak for them. We had multiple discussions with our sponsor about the decision that we made, and unanimously with both of our sponsors, the rest of the board and management this [recapitalisation plan] was determined to be the best step for today.

 

" If we were to get into a situation that is outside of what we' re expecting to see happen, we' ll have a whole new set of discussions. I don' t have indications at this point, that we' re not all on the same page,&rdquo Snyder replies.