Keppel Pacific Oak US REIT: How Resilient Is It?

With the Fed Rate hike cycle nearing its end, investors now know how high SOFR may go. With the maximum expectation of 01 more rate hike, the highest SOFR can be is 5.5%, with rate cuts happening from 2025.

With these known parameters, I will evaluate how resilient Keppel Pacific Oak (KORE) is.

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Fundamentals of KORE

KORE is a REIT focusing only on US office properties. Its loans are structured to follow SOFR rate (equivalent of SORA but in USA). KORE's Leverage ratio is currently 39.1%, ICR is 3.3 times and all in average debt cost is about 4.05%.

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KORE Debt and Hedging Profile

KORE has done a good hedging strategy against the rising interest rates. The REIT has said that every 50 basis points increase in SOFR (approx 2 Fed Rate hikes) will reduce DPU by 0.072 cents.

Currently KORE gives 2.48 US cents every 6 months. This means with the Fed rate hike reaching its peak, the expected dividends KORE gives is 4.9 US cents for the full year. In addition, given how staggered KORE's debt maturity is (over 5 years), dividends are well protected and will not be shocked by any loan issues.

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Leverage and Valuation

Like other US office REITs, KORE has experienced revaluation losses (13% last year), however growing rentals it has built in the leases and well positioned Grade A freehold office buidlings have ensured valuations do not get bombed out like Manulife US REIT.

In addition, KORE has a diversified portfolio of tenants which means the impact from a loss of 1 customer is small (unlike what was felt at Digicore US REIT)

All in all, come end 2023, I still expect KORE to report revaluation losses due to higher risk free rates in USA. However, I am expecting a maximum of 13% revaluation loss because the magnitude of rate hikes in 2023 is smaller than in 2022. This means KORE leverage ratio will move to 44.9%, just shy of MAS's requirement but still a "safe REIT". In addition, with its ICR at 3.3 times, it will take a large combination of property income to fall and spike in interest rates to cause it to go below 2.5 times (regulatory limit set by MAS)

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Dividends

As said, I expect dividends of 4.9 US cents per year for owning the shares. With KORE having a relatively strong balance sheet and portfolio, the risk of equity raising is small and if it happens the magniture of cash call would be small as well.

With 12%of debts due, I expect the hedging for this tranche of debt to expire and a higher interest cost can be expected that pushes dividends down to a further 4.8 US cents.

With interest rates stabilising at 3% mark, I expect KORE's all in interest cost for debts to be at 4.1% (current all in interest cost is 4.05%). Dividends at this stage, should be around 4.9 US cents as well.

Evaluation

I am happy to own this REIT. At 4.8 US cents and 20 US cents share price, KORE is now a 24% dividend yielder. My sense is the fear of US office supply glut will not affect KORE much and its capacity to remain at 4.8 US cents (100% payout ratio) or 4.5 US cents (90% payout ratio).

KORE has its merits to be owned. In the current high interest rates environment and weak US office space, I feel a 10% dividend yield on KORE is a fairer comparison which puts it at 45 US cents. However, should interest rates start to fall to reach the average of 3% interest, it makes KORE even more valuable due to a decline of risk free rates.

When that happens, KORE leverage ratio will fall (inverse relationship of Cap rate and property valuation). At such times, it is likely dividend investors will demand a 8% yield for KORE. I am expecting KORE to be a 4.9 US cents dividend machine with 8% yield; target price in the region of 62 US cents when interest rate stabilises.