• 1H21 NPI and distributable income met expectations, at 46% of our FY21e estimates. Despite higher rental reversions and income contributions from Park Tower, NPI declined 2.3% YoY due to lower portfolio occupancy and transient parking income.
• Two new properties were acquired in new markets with longer WALEs and higher occupancies than portfolio. We expect greater resilience and earnings visibility from an enlarged portfolio.
• Maintain ACCUMULATE and DDM target price of US$0.94 (COE 9.5%). FY21e/FY22e DPUs lowered by 10.5%/0.7% to reflect lower carpark income and softer leasing, offset by reversions and rental income from new acquisitions. Catalysts include improved leasing and a greater return to office.

The Positives

+ Positive reversions. Prime signed 52,349 sq ft of leases in 2Q21 at positive rental reversions of 10.5%. Excluding short-term lease extensions of 9,931 sq ft, rental reversions were 13.3%. This could be credited to leases signed at 101 South Hanley and Tower 909, where expiring rents are 11-13.5% below market. Positive rent reversions are expected going into 3Q, as portfolio rents are below asking rents by 6.4%.

+ Acquisitions enhance resilience. As of 23 July, Prime completed the acquisition of two new properties: Sorrento Towers in San Diego and One Town Center in Florida. San Diego is one of the top 10 tech cities in the US, where demand from the biotechnology, biopharmaceutical, international trade, high-tech and defence sectors is strong. South Florida is one of the top 10 states for population in-migration thanks to its favourable tax climate and quality of life. These acquisitions introduce Prime to two new markets and increase its exposure to key industry sectors. They have also extended its portfolio WALE from 4.4 to 4.6 years. Occupancy at both properties is above portfolio occupancy of 91.7%, at 98.2% and 94.7% respectively. This improves earnings visibility. The acquisitions were funded by debt and equity. Proforma DPU could be lifted by an estimated 2.4% after acquisition, based on FY20 figures.

The Negative

– Lower portfolio occupancy and carpark income vis-à-vis a year ago. Despite its positive rental reversions and contributions from Park Tower acquired on 24 February 2020, 1H21 gross revenue climbed only 2.6% YoY. This is due to lower portfolio occupancy of 91.7% as compared to 93% a year ago, as well as reduced transient parking income which historically comprised mid to high single digits of Prime’s topline. Property expenses also increased 25.4% YoY with new expenses from Park Tower. As such, NPI and distributable income fell 2.3%/1.3% YoY. DPU declined 5.4% YoY from a larger unit base.

Outlook

Leasing weakness may persist in 3Q21. Aided by widespread vaccinations and a return of employees to their offices, physical occupancy increased to 25-30% from 15-20% in the last 30 days. Leasing, however, remains below pre-pandemic levels, especially with continued new supply in CBD submarkets. National office vacancies rose to 17.2% in 2Q21 from 15.7% in 1Q21. Although Prime has been discussing leasing with prospective tenants especially in Denver and tours of office space increased over 80% from January to May 2021 according to VTS, actual space commitments usually lag leasing decisions by a few months. This means that committed portfolio occupancy can be expected to bottom out only in 4Q this year.

Maintain ACCUMULATE and DDM TP of US$0.94.

We factor in additional income from its newly acquired properties but lower our rental and occupancy assumptions for FY21e to capture declines in its carpark income and a softer leasing market. After accounting for a larger unit base, DPU estimates for FY21e/FY22e have been lowered by 10.5% and 0.7% respectively. Our TP is largely unchanged. Current price translates to FY21e distribution yields of 8.1% for total potential upside of 22.0%.