KORE US REIT (CMOU.SI) Earnings Call Transcript & Summary

Good morning, and welcome to Keppel Pacific Oak US REIT's First Half 2024 Financial Results Webcast. My name is Brenda, and I represent KORE on the Investor Relations front. Before we begin, let me introduce the management team on the session. We have CEO, Mr. David Snyder; and CFO, Mr. Andy Gwee. We will start off the webcast with an overview of KORE's financial and operational performance for the first half of 2024, followed by the question-and-answer session. Before we begin, we would like to run through some housekeeping. For analysts who are joining us on the Webex platform, please be reminded to mute your mic throughout the presentation. If you would like to ask a question, please click on the raise hand button and wait for our queue before you post your question. For those joining us online via the webcast platform, please type your questions via the chat box provided. Without further ado, I will now hand the time over to the CEO, Mr. David Snyder.

Thank you, Brenda. Good morning, everyone, and thank you for joining us today. Let's go ahead and start on Slide 4. KORE announced its recapitalization plan on February 15 because KORE's leverage had risen due to the 2023 year-end valuations, resulting in lenders becoming even more concerned about KORE and the overall U.S. office market. As such, we took the proactive measure to spend distributions beginning with the second half 2023 distributions with the expectation that distributions will be suspended through the second half 2025 distribution that would otherwise be paid in the first half of 2026. By suspending distributions and spending capital wisely, KORE's goal is to maintain leverage within the MAS limits and bank debt covenants. Though there is always a risk that asset valuations could change enough to cause KORE to exceed MAS limits or breach the bank debt covenants. The recapitalization plan does not anticipate KORE selling any buildings at significant discounts to their valuations, nor does it anticipate KORE selling any properties during 2024 or 2025, given current market and lending conditions. If conditions change, we would pursue asset sales sooner. As part of the recapitalization plan, KORE will attempt to refinance the loans that are due in 2024 and 2025 prior to maturity. Meanwhile, KORE will continue to invest in the portfolio with the goal of maximizing NPI and maintaining occupancy throughout the recapitalization period and restarting distributions for 2026 at the highest appropriate level, balancing the capital needs of the REIT and the desire to distribute income to unitholders. Moving on to KORE's first half 2024 key highlights on Slide 5. We leased more than 534,000 square feet of space in the first half of 2024, equivalent to 11.1% of the portfolio NLA. The majority of the leases signed were in Seattle - Bellevue/Redmond, Denver and Orlando. Portfolio committed occupancy inched up to 90.7% at June 30, 2024, an increase from last quarter and December 2023. Income available for distribution was down 8.8% year-on-year, mainly due to higher financing costs, while net property income was down 4.2% year-on-year. Cash NPI was only 1.6% lower year-on-year, mainly due to lower recoveries in car park income. The interest coverage ratio was 2.9x, and KORE's aggregate leverage has decreased slightly to 42.7% at June 30, 2023 (sic) [ June 30, 2024 ]. On July 19 and July 29, KORE early refinance or extended $170 million of its loan facilities that were originally due in the fourth quarter of 2024 and the third quarter of 2025. I will now hand it over to Andy to elaborate on KORE's financial performance.

Thanks, Dave, and good morning, everyone. On Slide 7, you can see the summary of KORE's financial performance for the second quarter and the first half of 2024. So as Dave had mentioned, income available for distribution had reduced by about 8.8% year-on-year, and that's due mainly to the higher financing costs. Adjusted NPI or in essence, cash NPI was down 1.6% year-on-year, and that's mainly due to lower recoveries of our property expenses, as well as lower car park income. For the low car park income reason being that last year, we had a lot of short-term or transient parking at our Plaza Buildings in Seattle because of nearby construction, which is nearing completion this year. So pursuant to the recap plan, no distribution will be declared for the first half of 2024. Next, Slide 8 is the snapshot of our balance sheet as at 30 of June and 31 December '23 for comparison. So as at the end of June, our NAV per unit improved by -- to about USD 0.71 per unit, and that's mainly due to the withholding of the distribution. So next will be Slide 9, our financial position, our capital management slide. You can see that aggregate leverage has fallen slightly to 42.7%, again due to the withholding of the distribution. Interest coverage was 2.9x, all-in average cost of debt was 4.47% per annum. This includes the amortization of the upfront debt cost. Excluding that, effective interest rate is about 4.36% per annum. So hedging-wise, we have about 69% of our variable rate loans hedged to fixed using IRS. And then, of course, you know that last week, MAS has published a consultation paper relating to the proposed amendment to the leverage requirement for S-REITs. And this includes proposing a single-tier minimum ICR of 1.5x, and the aggregate leverage is capped at 50%, which, in essence, will sort of provide some form of relief for S-REITs on the back of the higher financing costs. Next, Slide 10. I think as you all may be aware, over the -- over last week and earlier this week, we have made a series of a couple of announcements on new facilities or loan extension that we have obtained from our banks. So those loans or extensions will be used to refinance our existing -- part of our existing loans or extend further. So you can see that on a pro forma basis, the chart on the right -- bottom right is showing the pro forma of the debt maturity, assuming we are -- assuming the refinancing and the extension are effective as at 30 June. So you can see that the loans that was -- that the loan that will be due in August next year, $115 million, we opt in an option to extend it by 1 year. Once we extend our option -- the extension -- the exercise of the option is at our sole discretion. Once we exercise that 1-year extension, that $115 million will be moved to 2026. That's the biggest chunk of our loan due in the next 2 years. For the loans that is due in Q4 of this year, 1 loan, $30 million, we obtained a 3-year extension -- we refinanced it for a 3-year -- on a 3-year new loan. So you can see that it will be the green tranche in 2027. And then for the $45 million that is also due in quarter 4 of this year, we had a new loan of $25 million for -- to extend it further to November next year. The remaining $20 million, we are currently in discussion with other banks to get new loans to cover that $20 million as well. And then we have other options on the table as well potentially. And that leaves us with the $40 million loan that will be due in February next year. So we will start talking -- or the bank wasn't ready to start talking about refinancing debt in Q1 and Q2 this year. So we will probably start discussion with the bank pretty soon in Q3. Hopefully, that we can get that done as soon as possible. If not then, we are also in discussion with other banks to potentially look at that as well. So you can -- as you can see, we also provide some pro forma numbers on the cost of debt. Assuming all these are done as said, 1 January this year, you can see that the effective interest rate or excluding the amortization will increase by about 3 bps per annum. All-in cost of debt, including amortization will increase to about 4.56%. And the reason being that once we refinance the loan, the remaining unamortized upfront debt cost for this loan have to be taken to the P&L immediately, which is why you can see that the effective interest rate increased lower than the all-in interest rate. And with that, the new weighted average term to maturity will be 2.6 years. And then hopefully, I've addressed most of the questions that you may have later on, on the refinancing of the loan, but feel free to ask later on. So with that, I'll pass back to Dave on the ops.

Thanks, Andy. Slide 12 highlights some of the reasons why we invest in the key growth markets we do and not in gateway cities. These key growth markets have grown to be more attractive to companies and individuals because of their low income tax rates, lower cost of living, better employment opportunities and more attractive lifestyles among other factors. All but one of our markets are in the top 20 markets to watch in 2024. Moving to Slide 13, you can see changes in committed occupancy by property. This quarter, KORE's committed occupancy improved to 90.7% as the majority of properties saw an increase in occupancy rates. On Slide 14, the line graph shows KORE's historical occupancy against the U.S. average, as well as the gateway cities. Over the years, KORE's occupancy rate has remained well above the U.S. average and gateway cities with the spread actually widening over time. Our 2 peers in Singapore are both currently below both the U.S. average and the gateway city average of about 10% to 12% below KORE's occupancy. Let's move to Slide 15. The second quarter of 2024 saw us lease around 199,000 square feet of space or 4.2% of portfolio NLA, bringing the total lease space for the first half of 2024 to 534,000 square feet or 11.1% of the portfolio. On this slide, we have included a new graph that shows KORE's executed leases from IPO through the first half of 2024. You can see here that the leasing momentum has remained relatively stable, aside from the drop in 2020 due to the COVID-19 pandemic. New expansion leases represented 36% of the space leased during the first half of the year. While we do still see leasing momentum in certain markets, it is unlikely we will assign the same volume of leases in each of the remaining quarters of 2024, and we have a lot of known vacates coming up this year with a large proportion occurring in the latter part of the year. However, we would hope to lease similar volumes of new and expansion space in subsequent quarters. Our built-in average annual rental escalation of 2.6% continues to provide growth for KORE. The rental reversion for the first half was negative 0.3% due mainly to renewals of Bellevue Tech Center, Maitland and Westmoor Center. Rental reversion for the second quarter was a positive 1.2%. Slide 16 highlights KORE's geographic and industry diversification. At approximately 67% of NPI, our tech hubs of Bellevue/Redmond, Austin and Denver continued to drive our portfolio performance. And with approximately 51% of our tenants by NLA coming from the sectors of TAMI and medical and health care, our industry-focused diversification continues to set us apart from our peers. On Slide 18, you'll find a comparison of the last 12 months rent growth at the national level, as well as in our key growth markets and in gateway cities. It looks like I skipped a slide and didn't turn the page properly here. Let's turn to Slide 17, where we highlight our low tenant concentration risk first. This key differentiator is driven by the fact that we have over 380 distinct tenants with no tenant exceeding 3.8% of portfolio CRI. The total contribution from our top 10 tenants is also quite low in comparison to our peer set at just 28.2% of CRI. Consistent with our portfolio focus, the majority of our top 10 tenants are from established TAMI firms located in the markets of Nashville, Denver and Bellevue/Redmond. Now, moving to Slide 18, you'll find a comparison of the last 12 months rent growth at the national level, as well as in our key growth markets and the gateway cities. The average of our key growth markets continues to outperform the gateway cities, though the U.S. average is slightly ahead, largely due to the Seattle - Bellevue/Redmond market, where CoStar showed negative rent growth in excess of what we're generally seeing at our properties in the region. If we normalize the Bellevue/Redmond rent growth, our key growth market would have rent growth of about 1.1% on average in excess of the U.S. Similarly, on Slide 19, you'll see a chart that shows rent growth projections for the next 12 months. The projected rent outlook for the U.S. gateway cities and KORE's key growth markets are projected to be largely negative. However, you will see on the next slide that the projections are not in line with historical outcomes. And again, if we normalize Bellevue/Redmond to what we are seeing, which is flat rents, our key growth markets would be negative 0.5%, which is better than the U.S. average. Slide 20 shows the comparison of the forecasted 12-month rental growth for our markets over several years in green versus the actual average growth of KORE's key growth markets during those actual time frames in blue. The key takeaway here is the KORE's portfolio rent growth has remained relatively flat even as projections from CoStar have fluctuated quite significantly. Let's move on to the market outlook on Slide 22. This slide highlights several U.S. economic fundamentals. U.S. economy is slowing, but continues to remain resilient. The Fed paused rate hikes for the seventh consecutive FOMC meeting in June as the U.S. labor market remained tight. Annual U.S. inflation fell for a third straight month to 3.0%, the lowest since June 2023. The Fed hinted that the U.S. Central Bank is closer to cutting interest rates with the first rate cut expected by some in September, though it may not start until after the elections in the U.S. On Slide 23, we highlight some information on back-to-office trends in the U.S. Fiscal occupancy rates in San Francisco and L.A. are still below 50%, while Manhattan return to office rates have improved. Regulatory changes make it trickier for Wall Street to allow working from home. The back-to-office trends started off with tech firms bringing back employees into the office and banks are now following suit. Citigroup and HSBC were the 2 banks known to be among Wall Street's most flexible and allowing employees to continue working remotely after the COVID-19 pandemic, but they are now requiring some employees to be in the office 5 days a week. The changes come as the financial industry regulatory authority, FINRA, the U.S. brokerage industry's main watchdog is set to adjust rules for monitoring workplaces in the coming weeks. Office using job growth was strongest in Sunbelt markets. In keeping with our goal of highlighting new and different advantages and benefits of our investment model, which includes key growth markets, a mix of suburban and CBD assets depending on markets and a focus on TAMI and health care tenants. Slide 24 shows that CBD office occupancy rates have decreased over the years, falling below the suburban office occupancy, while KORE continues to outperform both. Downtown office properties, once crowned as being trophy assets or in some cases, now seen as being nearly toxic, though in certain markets, the CBD is still the strongest location. There are still tenants who wish to be downtown, but many are shrinking their real estate footprints aggressively once their leases come due. Moving on to Slide 25. You will see leasing activity in the U.S. by sector. The TAMI sector led despite pullback from large tech firms. This reinforces KORE's investment thesis, focusing on the fast-growing TAMI, medical and health care sectors across key growth markets in the U.S. Similarly, the bulk of our new leases signed in the first half of 2024 were mainly from TAMI tenants. On Slide 26, we close off the main portion of the presentation with a summary of KORE's unique value propositions, including a strategic presence in several of the fastest-growing states and strongest markets in the U.S., its exposure to the fast-growing TAMI and medical and health care sectors, our highly diversified portfolio with low tenant concentration risk, as well as our resilient operations with built-in average rental escalations for further organic growth. Finally, but very importantly, if we move to Slide 27, and we hope unitholders will understand that while distributions to unitholders are slated to be suspended until the end of 2025, beginning of 2026, KORE would have to bear the withholding tax based on the proportion of unitholders who failed to submit their U.S. withholding forms and certificates. This would negatively impact KORE and its unitholders by reducing the income that could be retained. Therefore, the Manager would like to strongly urge all unitholders to continue to submit the relevant tax forms to reduce KORE's withholding tax burden. Thank you all for your time and attention. And with that, I'll turn it back over to Brenda.

[Operator Instructions] So first, we have Vijay.

First of all, congrats, I think a commendable set of results considering the market conditions, both in terms of operational front and refinancing front. Okay. With the conditions now looking slightly better, I mean, your refinancing has been relatively taken care of. Operational-wise, things seems to be looking better. How should an investor look at from a potential distribution point of view? Would it still be second half of 2026 -- I mean, second half of 2025? Or what should be the factors that could change your mind to make your distribution start early?

Yes. Thanks, Vijay. Nothing has changed at this point with our timing, and that's because nothing has changed in the sales market, if you will, in the United States for real estate. What we need to see to be able to make changes would be banks coming back to the lending market and lending against U.S. office. As of today, that is still not happening in the United States. We're starting to see some sales transactions take place. Those are almost exclusively from the CMBS workouts or bank loans that have been foreclosed or where keys have been handed back to banks and the banks are trying to move them. And again, even there, that's almost exclusively very small transaction sizes. So smaller than anything we would probably like to sell because there's no financing for those particular buyers. So, once we see that market change and we can obtain financing more easily, and we would be able to sell to buyers who could obtain financing more easily. We'll sell 1 or 2 of the buildings that we've had in a position that we'd like to sell for the last couple of years I've been talking about, and then we would move back into being able to make distributions again because that would allow us to rightsize the balance sheet. So really, it all comes down to getting the balance sheet rightsized, getting leverage a little bit lower than we've got it now. We really like the direction MAS is planning to go. That simplifies things, but it doesn't really take the pressure off of a 50% leverage limit that still makes lenders cautious about anything that approaches 45%. But having flexibility in terms of the coverage ratio is a good thing. So nothing's really changed for us. It all really depends on the U.S. side of the market, but I think seeing banks now having properties, some of them actually marketing some, seeing a few more people handing keys back to banks and seeing some of the CMBS starting to get worked out, gives me hope that will be happening as we get into 2025. That's what we saw out of the financial crisis was when that started happening when the CMBS market really started to solve the problem by bringing things to market and banks followed, not long after we started to see financing available to the industry again, and that's what's going to bring everybody out, I think. And that's what's going to make it possible for us to get started on distributions again.

Got it. That's a lot clearer. I mean, just a few follow-up on this. I mean, I just want to know what's the bank covenants are at this point of time? And even after MAS changes, you don't plan to be comfortable above -- going above 45%. Would that be right?

Vijay, I think in terms of the bank covenant is the same for the new loans as the rest of our portfolio loans as well. ICR of 1.5x, as well as leverage of 15%. So that's consistent in terms of the new loans that we are taking. In terms of where the -- are we comfortable going above 45%, until the banks are comfortable with us going above 45%, we will, as much as possible, try to avoid crossing over that, that so-called hidden or bottom line in terms of the threshold that most market players are setting below the 50% MAS demand.

I think, Vijay, at some point, we'll see the banks, even Singapore lenders that are more what we use, the U.S. financing is mostly for individual transactions, secured debt, that sort of thing, that's not back. There are lenders here in Singapore that are continuing to lend or at least roll forward loans and potentially making new loans, which we would be trying to take advantage of, as Andy already talked about a little bit briefly. But once we get to the point where we're able to obtain some new credit facilities that give us some flexibility, we might be willing to temporarily go above 45% a little bit. If we've got plans that have us say marketing buildings and that sort of things for sale, if we're comfortable, we will get them sold, we might temporarily go over 45%, but not until we've got credit available that gives us the flexibility to do that.

Got it. Sorry for harping again on the distribution point. I just want to consider what is your valuation outlook? And if the valuation is minimally lost or in a net profit position, technically speaking, with these loans refinancing, then you wouldn't be able to withhold your distribution for the year. Is that right?

I mean, at the end of the day, that's an assessment we still need to make as at the year-end, but probably because we have already announced the recap plan, and most of the banks gave us the refinancing on new loans on the expectation that we keep our leverage at a reasonably lower than 45% position. And also, we need to see what is our capital needs for next year and where our -- I mean, we will do a budget in terms of where our rental income will be like towards the end of the year as well. And then we will do a holistic and oversight in terms of looking at our cash flow for 12 to 15 months after the end of 2024 to see whether -- where we are in terms of operational working capital needs, too. Yes.

Yes. And Vijay, there's really 2 prongs that we're relying on with -- under the MAS rules, if you will, in terms of withholding distributions and not making them right now. You're familiar with the one, which is why you're asking the question. If you're not in a loss position, don't you need to distribute, but there is another prong that we also are relying on, which is what we would continue to rely on to not make the distribution strengthen the company, strengthen the properties, strengthen the balance sheet and then go ahead and restart distributions under the time frame that we're talking about. So, no, there's not a must for us to restart distributions just because we hopefully will have a valuation that comes in either quite close to where we are. If we're fortunate a valuation that actually gives credit to and accounts for the money that we're investing into the properties as well or a slight loss. And in any of those situations, we would still anticipate withholding distributions in 2025, while we continue to rebalance.

Got it. So if the bottom line is that, we should see some divestments before we can consider some sort of distributions back at this point of time. And that's your thinking at this point of time, right?

Yes. We've got to be really prudent for the unitholders and the portfolio. And until they're -- so, I mean, again, the other thing that would provide us the ability to restart distributions could be flexibility with banks coming back and providing loans at which point we could say, Great. We can go ahead and make our distributions. We use those loans to cover the capital needs in the portfolio, which we believe will continue to drive up certainly by 2025 with rate cutting environment that we expect to see. We expect to see increasing valuations, and that would help keep us flat, give us a comfort level. But right now, we don't see it really in the cards in the near term that we're going to have either the ability to sell buildings or the ability to have those sorts of credit facilities for banks that will enable us to do all of that. So for now, we just proceed with the plan that we announced and hope that things change and we can do things a little bit faster or differently than we had originally planned, but we're on track with the plan now. A lot of the refinancings have already happened. Operationally, I feel like with the leasing that we've done, we're probably ahead of plan on that as well. So we feel as good as we really can at this point about fulfilling the things that we told unitholders, we were going to focus on.

Got it. Certainly, yes. I think another way is congrats on the early refinancing. Maybe can you give some more color in terms of -- I mean, the overall rate looks quite -- a change looks very minimal. So can you give some color in terms of what is the new refinancing cost? Is this going to be fixed or floating? And what kind of margins is the banks commanding now?

I think in terms of the reason why the impact on the portfolio are in is not so much is because it's really about $55 million worth of loans that has been refinanced. The change in the loan margin, I would say, on average, is about 30, 40 bps. We are looking at about just a low margin alone. Low margin of about, I would say, 1.7% to 2% plus SOFR for new variable rate loans nowadays. Of course, we managed to get better-than-expected rates for the couple of refinancing that we did. For the extension of the $115 million, that is at the same rate of the original loan. So that's not a refinancing. That's more of an extension of the existing loan by a further year from August '25. So that particular loan is at the same rate that is currently is now. So if you were to get go for a new loan now, I think expect somewhere between 1.7% to 2% loan margin plus SOFR.

Next, we have Derek.

Can you hear me?

We can.

Congrats on the refinancing. And I'm happy to say that I am wrong. So -- but we got to move on. We want to move on. Yes. But maybe can I come back? I think Vijay asked a lot on the refinancing, but I want to get more color, if you can. Do you reckon that the banks are happy to refi again after this round? I know it's very initial, but is it something that the conversation of the banks is like we are happy to help you once and in the next round of refinancing, you have to find -- you have to like reduce our exposure. Is that going to be that further in the medium term?

I think it's a mixture. There will be banks that will want to reduce their exposure. But I think a lot of the banks now are actually waiting to see whether the U.S. market condition is at the bottom and is it turning around. I think if it starts to turn around, and as Dave has said, U.S. bank starts to lend again for transaction. I would expect the Asian bank to follow suit in terms of being more comfortable to lend for either refinancing or even for fresh loans.

And Andy can correct me if I'm wrong, but from my discussions with banks and our internal folks helping us with the lending, our main banks have not expressed that they want to get out after these current ones. So we have some small financings here or there where we may have a lender or 2 that might be considering that. But I think, as Andy said, most of those are really waiting to see what happens. But our main lending relationships have not expressed anything along those lines.

Yes, correct.

Okay. Got it. And I'm also fairly amazed at the all-in cost of debt. I mean, it's at a level which I think shows the strength of the Keppel Group NIM, right? But could you just understand on a like-for-like basis, I understand that you have to pay off your all-in cost at once. But if you look at it, margins wide, did it expand or compress?

Expanded, definitely. So for the 50 -- for the 2 loans that we refinanced, one gives them [ $125 million ]. Average expansion of the low margin, I would say, is about 30 to 40 bps. So if sentiments turns better, I would expect the low margin to be lower. But at the moment, I think we probably work on a more conservative side in terms of expecting at least a new loan margin of 1.7% to 2% plus SOFR for new loans to be taken.

Which is also, Derek, one of the reasons why we're pretty comfortable with some of the shorter extensions of some of these loans because in a year or 2 and some of these are actually going to come due and we'll be doing real refinancings at that point. We would hope to see better rates.

Yes. And that's the reason why we only did a 1-year attention for the $115 million due next year. You can see that originally, our 2026 tranche is very minimal. We want to -- we do not want to sort of [ latent ] a particular year like '27 or '28 with a huge refinancing requirement as well. So that is a bit of a strategic move on our side as well to try to layer up or other even up the maturity as much as possible.

Got it. Okay. So just wondering, right, so you mentioned that the banks are willing to lend in the assumption that your gearing remains sub-45. But is there a concerted effort or, let's say, a lever that the banks want to do, let's say, bring it down to 35% by, say, end of 2025? No.

I mean, after [ additional ] result, you can see a lot of that actually are going to have trouble with leverage, right? I think approaching 35% is...

Not [indiscernible] yes.