• 1Q23 distributable income was below expectations and 21% of FY23e forecast. The decline of 28.8% to US$14.9mn was due to Prime increasing management fees paid in cash from 20% to 100%, higher interest expense, absence of lease termination income, and higher operating expenses. Excluding the higher proportion of management fees in cash, distributable income is still down 22.5%.
• Portfolio occupancy dipped slightly to 88.6% from 89.1% in 4Q22, with overall rental reversions of -2.6%.
• Maintain BUY, DDM-TP lowered from US$0.70 to US$0.46 as we lower our FY23e DPU forecast by 18% due to management fees paid all in cash, lower occupancy, and higher costs. We also cut FY24e and FY25e DPU by 18% and 15% respectively. Catalysts include improved leasing and a greater return to the office. Prime is currently trading at 0.3x P/NAV and below pandemic lows, and we believe that most of the negatives are already priced in. The current share price implies FY23e/FY24e DPU yield of 23/25%.

The Positive

+ Extension of debt maturities. Prime is in the process of extending its 4-year term loan and RCF under its main credit facility (c.34% of total loans) by one year to July 2024 for an extension fee of 10bps. Expected completion is June 2023. This gives Prime some respite amid the credit crunch situation in the US.

The Negatives

- Portfolio occupancy dipped to 88.6% from 89.1% in 4Q22. The biggest contributors to the decline were Tower 1 at Emeryville (-7ppts QoQ to 69.1%) and Sorento Towers (-2.8ppts QoQ to 94.4%).

- Slowdown in leasing volumes. Prime signed 64.4k sq ft of leases in 1Q23 (-62% YoY and -55% QoQ). However, leasing activity picked up in April 23 with c.38k sq ft of leases executed. Portfolio rental reversions for the quarter were -2.6%, impacted by two renewals with minimal upfront tenant improvements Capex, but with high positive net effective rent reversions. Excluding the two abovementioned renewals, 1Q23 rental reversions would have been +3.2%.

- Gearing increased 1.6ppts QoQ to 43.7%, due to the increase in borrowings to fund 2H22 distribution at the end of March 2023. 79% of debt is either on a fixed rate or hedged (82% in 4Q22), with 62% of debt hedged or fixed through to 2026 or beyond. After the extension of debt, Prime has no refinancing obligations till July 2024. Prime’s effective interest cost for the quarter increased 30bps QoQ to 3.7%, and its interest coverage ratio is at 3.8x.

• FY22 DPU of 6.55 US cts was slightly below our estimates, mainly due to higher interest expense (+27.2%) and lower occupancies (89.1%).
• Despite portfolio valuation declining 6.7% on higher discount and cap rate assumptions, gearing at 42.1% and interest coverage at 4.1x remains well within regulatory limits.
• Maintain BUY, DDM-TP lowered from US$0.88 to US$0.70 as we lower our FY23e-FY25e DPU forecasts by 12-15% due to lower occupancy and higher financing costs. Our cost of equity increased from 10.55% to 11% as we roll forward our forecasts. PRIME is our top pick in the US office sector for greater tenant exposure to STEM/TAMI sectors. Catalysts include improved leasing and a greater return to office. Prime is currently trading at 0.6x P/NAV and below pandemic lows, and we believe that most of the negatives are already priced in. The current share price implies FY23e/FY24e DPU yield of 13.6/14.7%.

The Positives

+ Strong positive rental reversions of 20.2% for 4Q22, continuing the trend of positive rental reversions for 11 consecutive quarters. Occupancy remained relatively stable, declining 0.5% QoQ to 89.1%. Leasing remains active, with activity coming from sectors such as scientific R&D services, finance, biotechnology, manufacturing and legal services. The 20.2% reversion was substantially from Crosspoint, where an existing tenant downsized from 84k sq ft to 57.5k sq ft and extended the lease to 2032, and a new tenant backfilled space and signed a lease till 2034 at >25% reversions.

+ 82% of debt is on fixed rate or hedged, with 66% of the total debt hedged or fixed through to mid-2026 and beyond. Prime has no refinancing obligations till July 2024. Prime’s gearing increased to 42.1% from 38.7% QoQ, mainly due to the decline in portfolio valuation, but remains well within regulatory limits. Its interest coverage ratio of 4.1x is also well above MAS’ threshold  of 2.5x to bring gearing limits up to 50%. Prime’s effective interest rate crept up to 3.4%, from 3.1% in 3Q22.

The Negative

- Portfolio value declined 6.7% due to higher discount and cap rate assumptions used by valuers. Across the board, cap rates increased by 50bps. All assets saw a valuation decline, with Reston Square (-14.2%, due to the non-renewal of anchor tenant), Village Center Station I (-12.1%) and One Town Center (-10.6%) having the biggest percentage declines.

•  9M22 distributable income (+9.2% YoY) was in line, forming 73% of our FY22e estimate.
•  Leasing activity in 3Q22 was close to the previous 2 quarters combined (246.2k vs 1H22 257.5k sq ft), with positive rental reversions of 10.1%. Occupancy remained stable at 89.6%.
•  No change in our forecasts. Maintain BUY, DDM-TP (COE 10.55%) unchanged at US$0.88. PRIME is our top pick in the US office sector for greater tenant exposure to STEM/TAMI sectors. Catalysts include improved leasing and a greater return to office. The current share price implies FY22e/FY23e DPU yield of 14.6/14.8%.

The Positives

+ Jump in leasing volumes. Prime signed 246.2k sq ft, or 5.7%, of portfolio CRI in 3Q22, which was close to the previous 2 quarters combined (1H2022: 257.5 sq ft). 52% of leases signed in 3Q22 were new leases, with leasing activity coming from the communications, legal services, real estate services, education and food services sectors. 3Q22 rental reversions came in at +10.1%, continuing the trend of positive rental reversions for the last 10 quarters.

+ 83% of debt is on fixed rate or hedged, with 66% of the total debt hedged or fixed through to mid-2026 and beyond. Prime has no refinancing obligations till July 2024. According to our calculations, every 100 basis points increase in interest rates would affect FY22e DPU by c.1.5%.

The Negative

- Occupancy remained flat QoQ at 89.6% for 3Q22 despite strong leasing momentum. Despite backfilling at Tower 1 at Emeryville (+18.2ppts); 101 South Hanley (+5.5ppts); and 171 17^th Street (+3.1ppts), portfolio occupancy remained stable as it was dragged down by a significant non-renewal at Reston Square, bringing occupancy down from 100% to 47.1%. The tenant, Whitney, Bradley & Brown, used to occupy c.50% of space in the asset before its lease expired in July 2022.

Outlook

Leasing activity spiked up in 3Q22 with renewed efforts by companies to encourage employees back into the office. According to JLL, office re-entry levels reached a post-pandemic high in the second half of September, and remote work is showing signs of losing momentum as the labour market tightens. With in-place rents c.6.7% below asking rents, Prime’s portfolio is primed for more positive rental reversions.

Maintain BUY, DDM TP maintained at US$0.88.

No change in our TP. The current share price implies FY22e/FY23e DPU yield of 14.6/14.8%. PRIME is our top pick in the US office sector for greater tenant exposure to STEM/TAMI sectors and the resilience of its portfolio. Catalysts include improved leasing and a greater return to the office. PRIME is also trading at an attractive 40% discount to book.

• esilient portfolio with eight consecutive quarters of positive rental reversions. Leases signed in 2Q22 enjoyed positive rental reversions of +10.9%.
• Minimally impacted by rising interest rates, with 86% of debt either on fixed rate or hedged through interest rate swaps. Around 51% of debts have hedges in place through to 2026.
• Maintain BUY, DDM-TP (COE 10.55%) lowered from US$1 to US$0.88 as we trim our FY22e-FY24e DPU by 1-2%. Our COE nudged up from 9.6% to 10.55% on higher risk-free rate assumption and market risk. PRIME is our top pick in the US office sector for greater tenant exposure to STEM/TAMI sectors. Catalysts include improved leasing and a greater return to office. The current share price implies FY22e/FY23e DPU yield of 11.4/11.6%.

Investment thesis

• 8 consecutive quarters of positive rental reversions. PRIME signed 85.7k sq ft, or 1.8%, of portfolio CRI in 2Q22, with an overall rental reversion of +10.9%; 47% of which were new leases. 2Q22 leasing activities were mainly from financial, professional services and healthcare sectors. Management guided that leasing demand and enquiries for its assets remain strong and active leasing discussions are ongoing for Tower 1 at Emeryville, Village Center Station 1, Tower 909, 222 Main and 171 17^th

• Resilient portfolio. PRIME has a diversified portfolio, with no single primary market contributing more than 11.7% of CRI and no single property contributing more than 13.8% of CRI. Portfolio occupancy remained stable in 2Q22 at 89.6%. PRIME also has a healthy WALE of 4 years, with well staggered lease expirations. Their tenant industry sector diversification also contributes to their resiliency, with 74% of tenants in established and growth (STEM/TEMI) sectors.

• Minimally impacted by rising interest rates, as c.86% of debt is either on fixed rate or hedged through interest rate swaps. About 51% of debts have hedges in place through to 2026, while c.18% of debts are hedged for the next 2 years. About 17% of debt is on fixed rate and matures in 2029. No debt expiring until 2024, assuming the exercise of extension options. PRIME has aggregate leverage of 37.8%. According to our calculations, every 100 basis points increase in interest rates would affect FY22e DPU by c.1.1%.

Outlook

As of June 2022, office-using employment increased by about 1.6 million (+4.8% YoY), and there were 1.06 million (+3.2%) more office-using workers than before the pandemic began. The US job market remain healthy and this has spurred many companies to add office space to house a larger workforce.

Leasing activity picked up in 1H22 with stronger demand coming from the financial, professional services and healthcare sectors. Physical occupancy across the portfolio is at c.50% as more tenants implement their return-to-work plans. With in-place rents c.5.3% below asking rents, PRIME’s portfolio is primed for more positive rental reversions.

Maintain BUY, and DDM TP lowered from US$1.00 to US$0.88.

DDM-TP lowered from US$1 to US$0.88 as we trim our FY22e-FY24e DPU by 1-2%. Our COE nudged up from 9.6% to 10.55% on higher risk-free rate assumption and market risk. The current share price implies FY22e/FY23e DPU yield of 11.4/11.6%. PRIME is our top pick in the US office sector for greater tenant exposure to STEM/TAMI sectors and the resiliency of its portfolio. Catalysts include improved leasing and a greater return to the office. PRIME is also trading at an attractive 25% discount to book.

• 1Q22 distributable income (+19% YoY) was in line, forming 25% of our FY22e estimate. It was lifted by the acquisition of Sorrento Towers and One Town Center in Jul2 and higher carpark income.
• Leases signed jumped 80% QoQ; 172k sq ft was signed at +3.4% reversions. Backfilling at Crosspoint (+5.4ppts) and 222 Main (+3.7ppts) was offset by non-renewals resulting in 0.4ppt decline in portfolio occupancy to 89.9%
• Upgrade from ACCUMULATE to BUY, DDM-TP (COE 9.6%) raised from US$0.94 to US$1.00 as we roll forward our forecast. Our COE nudged up from 9.5% to 9.6% on higher risk-free rate assumption. Prime is our top pick in the sector for greater tenant exposure to STEM/TAMI sectors. Catalysts include improved leasing and a greater return to office.

The Positive

+ Jump in leasing volumes. Prime signed 172k sq ft or 3.9% of portfolio NLA in 1Q22. This was 80% higher QoQ; 32% of which were new leases. 1Q22 reversions came in at +3.4% compared to +9.8% in 4Q21. Some new leases were signed on space that had been vacant for more than 12 months, and hence are excluded from reversion calculations. The management said that leasing demand was stronger across its market and observed deeper tenant interest lists. Prime signed 46k sq ft of leases post quarter, bringing YTD reversion to c.6%.

The Negative

- Non-renewals chipping away at occupancy. Portfolio occupancy dipped QoQ from 90.3% to 89.9% despite backfilling at Crosspoint (+5.4ppts) and 222 Main (+3.7ppts). Portfolio occupancy was dragged down by a significant non-renewal at Tower I at Emeryville, bringing occupancy down from 70.4% to 58.9%. Five out of 14 assets have committed occupancies below 90% and require backfilling. Prime will continue to recognise pre-termination income for WeWork’s space at Tower I at Emeryville until early-4Q22 and for another pre-termination at One Washingtonian Centre until 3Q22. This could result in potential upside for Prime should it be able to lease out the space before the pre-termination fee runs out. Prime has also started marketing the space for a known non-renewal at Reston Square. The tenant, Whitney, Bradley & Brown, occupies c.50% of space in the asset and will be vacating its lease when it comes due in Jul22.

Outlook

Leasing activity picked up in 1Q22 with a broader tenant list and interest coming from small, medium and large space users across more industries. With expiring rents c.6% below asking rents, Prime’s portfolio is primed for more positive rental reversions.

• 9M21 NPI and distributable income met expectations, at 72% of our FY21e estimates.
• Strong leasing quarter with 4.3% of NLA signed at 19.2% reversions. Two pre-terminations announced, but pre-termination fees likely to cover rents till 4Q22.
• Maintain ACCUMULATE and DDM target price of US$0.94 (COE 9.5%). No change in our estimates. Current share price implies FY21e/FY22e DPU yield of 7.6%/8.8%. Prime is our top pick in the US Office sector for greater tenant exposure to STEM/TAMI sectors. Catalysts include improved leasing and a greater return to office.

The Positive

+ Strong leasing quarter with respectable reversions of 19.2% (1Q21: 9.5%; 2Q21: 13.3%). c.4.3% of portfolio NLA signed in 3Q21, 3.6x higher QoQ, of which, most were renewals. New leases formed 17.5% of NLA signed. Half of 3Q21 NLA signed was with a legal tenant, Arnall Golden Gregory, located in 171 17^th Street in Atlanta. The tenant signed an early renewal on their leases expiring in 2024, which will extend its lease until 2035. Reversion for this lease was c.20%, while reversions for the remaining leases ranged from positive single digits to low double digits. A manageable 10.2% of leases by CRI are expiring in FY22. Passing rents for 10 out of 14 of Prime’s assets are currently below market rents, implying the potential for positive reversion averaging 7.5% for the portfolio. The is because growth in market rents has outpaced the scheduled escalations embedded in Prime’s leases.

The Negatives

- Two pre-terminations announced; pre-termination fees likely to cover rents till 4Q22. A tenant at One Washingtonian Center pre-terminated its lease, resulting in a 15ppt decline in building occupancy, from 95.6% to 80.6%. Pre-termination fees will cover rents till Nov22, providing upside for Prime, should the manager be able to lease out the space before pre-termination fees are depleted. WeWork, one of Prime’s top 10 tenant contributing 2.5% of CRI, announced the pre-termination of its lease at Tower I at Emeryville. WeWork’s security deposits, in the form of cash and other collaterals, will cover rents until 4Q22. More details to follow as Prime and WeWork are currently discussing the pre-termination fee and date of vacancy. Separately, a tenant occupying 2.6% of NLA at Reston Square will not be renewing its lease when it comes due in Jul22. The tenant was acquired by another corporate and will be relocating to the acquirer’s building. In place rents of US$443.46 are currently 14.7% above market rents of US$37.00, implying negative reversions for this space.

- Portfolio occupancy slipped 0.3ppts QoQ from 91.7% to 91.4%. This was largely attributed to the pre-termination at One Washingtonian Center.

Outlook

Adapting to earlier lease commencement dates. US leasing volume has picked up, with improvements lease tenures and reduction in tenant incentives. However, some tenants with larger footprints may require longer timeframes for decision making. The delay in decision making results in a more immediate intended occupancy date, as leases are signed closer to expiry. To adapt to tenants’ changing leasing behaviour, Prime is evaluating strategies to shorten the timeframe for tenants to move in. We think this could involve Prime pre-empting tenant’s space configurations and speculatively reconfiguring vacant spaces ahead of lease conclusion - a strategy that has garnered much success for one of its peers.

More significant return-to-office likely to happen in 1Q22. Physical occupancy for 3Q21 was c.30%, an improvement from c.20% in 2Q21. While many surveyed corporates expressed interest in returning to the office in 3Q21, new waves of the virus delayed return-to-office plans. We expect significant return-to-office will likely happen in 1Q22, delaying a more meaningful recovery in carpark income. For reference, carpark and ancillary income contribute c.7-9% of pre-pandemic revenue but is currently c.30-35% below stabilised levels.

Maintain ACCUMULATE and DDM TP of US$0.94.

No change in our estimates. Current share price implies FY21e/FY22e DPU yield of 7.6%/8.8%. Prime is our top pick in the sector for greater tenant exposure to STEM/TAMI sectors. Catalysts include improved leasing and a greater return to office.

• Results in line with expectations; 99% rent-collection rate, few deferrals (<0.3% of GRI) and minimal lease expiries (2%/8.7% in FY20e/FY21e) underpinned Prime’s income resilience.
• Continued strength in leasing. Most tenants still signing c.5-year leases.
• Maintain BUY and DDM target price of US$0.94 (COE 9.5%).

The Positives

+ Resilient income; on course to outperform NPI target. While 9M20 results exceeded expectations due to its Park Tower acquisition in 1Q20, 3Q20 results were stable QoQ. Prime continued to receive 99% of its rents, with minimal deferrals of US$0.27mn (0.25% of GRI) YTD. For the rest of FY20 and FY21, only 2.0% and 8.7% of its leases by GRI are due to expire. Portfolio WALE was 4.6 years. With minimal lease expiries, few deferrals and high rent-collection rates, Prime is expected to outperform its IPO NPI target by c.10% in FY20e.

+ Robust leasing. New leases of 83k sqft brought total space leased YTD to 166k sqft. The new leases were signed at a rental reversion of 8.9%. Over 60% signed YTD was for renewal or expansion by existing tenants. Lease terms and durations were about the same as pre-Covid levels. The majority was signed for about five years. Less than 10% was for a year or less. New tenants were largely from the established and technology sectors.

The Negative

- Portfolio occupancy dipped 0.4% QoQ to 92.6%. The decline in 3Q20 portfolio occupancy reflected natural expiries at Tower 909. Additionally, vacancies last quarter at Village Center Station I and 171 17^th Street had yet to be filled. Occupancies for both remained at 65% and 86% respectively. Nonetheless, Prime is starting to receive interest in these properties. At Tower 909, interest came from a major tenant that is expanding. Over at Village Centre 1, it came from companies looking to relocate to the urban center of Denver for hub-and-spoke. Interest in 171 17^th Street spiked after Microsoft’s move to the adjacent building.

Outlook

Under the new normal, Prime believes that the relevance of office space is now more hinged on it being a space for workplace collaboration, rather than it simply being a space for people to work. Most of Prime’s office buildings have lounges and Prime intends to convert these into collaboration spaces. Near term, it is working with tenants on their return to office. In the medium term, it will look at how it can modify its existing office spaces to support tenants’ needs for the longer term.

On the acquisition front, Prime has been exploring opportunities in Atlanta, Salt Lake City and Philadelphia. Although there have been more deals in the market, there has not been any distress-selling for it to pick up quality buildings at good bargains. Prime stands ready to seize good opportunities with its gearing of 32.7%, interest coverage of 5.8x and US$98.9mn undrawn facility.

Maintain BUY and DDM TP of US$0.94. Current price translates to a FY20e distribution yield of 9.6% for total potential upside of 34.1%.

• We still favor Prime US REIT for its diversified portfolio and organic growth potential derived from rental reversions and escalations. Prime US REIT remains resilient.
• Overall occupancy dipped slightly QoQ to 93.0%. Nevertheless, portfolio WALE remains at 4.8 years. Only 3.3% and 7.4% of the leases by GRI are due to expire in FY20 and FY21.
• FY20e yield remains attractive at 8.6%; Maintain BUY at a higher target price of US$0.94.

The Positives

+ NPI and DPU slightly surpassed expectations; minimal impact amidst COVID-19. Gross revenue and NPI is up 5.7% and 7.6% YoY in 1H20, attributable to its accretive acquisition of Park Tower acquired in 1Q20. NPI and DPU slightly surpassed our expectations, forming 50.6% and 51.5% of our estimates for FY20e. Income stream for 1H20 remained stable as 99% of the rents are collected for each month in 2Q. While rent deferrals for 8 small retail tenants (comprising 0.2% of CRI) are provided, no rent abatements are given. Rent collections in July continued the same trend in Q2. Built-in rental escalations of c.2% in leases contributing to 99.8% of the CRI provides a clear organic growth outlook for the REIT.

+ Stable lease expiry profile; Strong leasing activity in 1H20. Portfolio WALE remains at 4.8 years. Only 3.3% and 7.4% of the leases by GRI are due to expire in FY20 and FY21. Strong leasing activity was observed in 1H20 as Prime reaped 82k sqft in new leases and renewals (of which 30k sqft was secured in 2Q) at an average positive rental reversion of 8.5%. Over 60% of 1H20’s leases were renewals and expansions. The portfolio’s reversion potential is underpinned by leases that are rented at an average of 7.5% below market.

+ Healthy gearing levels and ample debt headroom. Prime’s gearing and interest coverage ratio improved from 33.7% to 33% and 5.1x to 5.4x respectively, with $91.4mn available undrawn facility to tap on for future growth opportunities. Effective interest rate for the portfolio has been reduced to 2.6% from 3.3%. 90% of the debt is locked into fixed interest rates.

The Negatives

- Overall portfolio occupancy dipped QoQ from 94.9% to 93.0%. Decline in portfolio occupancy in Q2 is mainly due to the expiring leases in Village Center I and 171 17^th Street. A property developer and Holland and Hart exited Village Center post-development of Village Center III. The market is still active and there has been interest from the financial and technology industry over the past 2 months. Also, Wells Fargo returned some of their space in 171 17^th street post expiry of the previous lease extension. The management is confident in leasing out the vacant space as 171 17^th street is the strongest submarket in Atlanta. This is supported by Microsoft’s decision to lease 100% of Atlantic Station, a property across the street from Prime’s property.

Outlook

Upcoming commercial supply into the markets that Prime has presence in continues to be minimal as majority of the buildings under construction are pre-leased. Markets with notable supply includes Midtown Atlanta (c.700k sqft), Salt Lake City (590k sqft) and St.Louis (457k sqft). Midtown Atlanta continues to attract large corporations and has benefited from a wave of tech-oriented companies; Microsoft recently leased 523k sqft in Atlantic Station (post-COVID), which brings preleased space in Atlanta to 2.8mn sqft (c.80% of available space). For the supply in Salt Lake City, it is a single building which saw pre-leasing activity from UBS and a technology firm.

We remain positive on Prime’s outlook due to its income stability supported by long WALE of 4.8 years, minimal expiries of 3.3% and 7.4% in FY20 and FY21 and high levels of asset and trade sector diversification. No property contributes more than 15.3% to net property income. Office using sectors like finance (1H20: 14.3%) and communication (13.5%) remains the largest income contributor to the portfolio. Despite heightened level of cautiousness surrounding new leases and expansions amidst uncertainty, Prime saw robust leasing activity in 1H20 which spilled over to 3Q20. Post 1H20, an additional 36k sqft of renewals and expansion leases were executed by existing tenants at positive reversions. This is testament of Prime’s asset quality and tenant stickiness, which we believe will allow Prime to thrive and not just weather through COVID-19.

Maintain BUY with a higher TP of US$0.94.

Our target price translates to a FY20e distribution yield of 8.6% and a total upside of 24.0%. We adjusted our revenue and NPI forecasts upwards to reflect the new leases and renewals signed in 1H19, resulting in an increase in FY20’s distributable income and DPU by 3.7% and 3.1% respectively. Our higher TP is mainly attributable to a lower cost of equity assumption of 9.50% (prev. 9.96%) to reflect the relative resilience of US office asset class.

The report is produced by Phillip Securities Research under the ‘Research Talent Development Grant Scheme’ (administered by SGX).