Manulife US Real Estate Investment Trust (BTOU) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to Manulife US REIT's First Half 2020 Financial Results Updates. [Operator Instructions] I'm pleased to introduce the management team joining us on this call from Singapore. We have Jill Smith, CEO; Robert Wong, CFO; and Carol Fong, Head of IR, who will be moderating today's session. Jennifer Schillaci, CIO, is also joining us from Canada. Carol, over to you.

Thank you, Aaron. Hi, a very good morning to all analysts and media. So sorry for having the call rather early on a Monday morning for some of you. However, it is never our style to have it in the evening or worst deal, evening of a weekend or public holiday, so we just don't believe in that. So this morning, we are very pleased to be able to share with you our solid one half 2020 financial results. I hope you have managed to catch a glimpse of our results or downloaded our slides that we had e-mailed across this morning. So for today's call, we will have Jill present the key highlights of our results; of course, provide COVID update on our portfolio; and our strategy moving forward. Under our Green Dot Series this round, we will be sharing the hottest topic, which is talk of the town on work from home impact, which Jill will share. So Jill's entire presentation should last about 15 minutes or so. After which, we will open up the floor for questions. So as we have about 40 analysts media who have signed up for this call, we hope to be able to answer all your questions after the presentation. So without further ado, Jill, please.

Good morning, everybody. Welcome to this call. Well, despite COVID-19 pandemic and the resulting sharp contraction in the U.S. economy, particularly in the second quarter of 2020, MUST first half results have outperformed. The distributable income is up 20% year-on-year, resulting in a DPU of USD 3.05, which will be fully, that's 100%, paid out to investors. Delivery of the good results was anchored by our resilient portfolio. Indeed, the portfolio remains robust with a long WALE of 5.7 years, and a very high occupancy rate of 96.2%. Against our peers, we have the longest WALE and the lowest expiries. Leasing momentum also has remained strong in the first half with just about 220,000 square feet leased in the first half and that at an increased rental reversion of 7.9%. On the capital management front, we financed our IPO loan for the Peachtree building in Atlanta at a low rate of 1.85%, which, of course, will save costs going forward. Digging slightly deeper into the financial highlights. Year-on-year, our gross revenue, NPI and DI, increased close to 20%, mainly from the contributions from the 2 acquisitions in 2019, that's Centerpointe in April last year and Capitol in October last year. This strong performance was partially offset by lower rental income, which we flagged before from Michelson and a lower carpark income due to the COVID-19 crisis. This resulted in a DPU, as I've already said, of USD 3.05 and was a little better than last year's DPU. Looking at a property level, our buildings have continued to deliver through our fortified portfolio, and you can see on Page 8 of the presentation those details. Moving on to our debt maturity. That, as ever, is well spread, ensuring that we have financial flexibility. And on Page 9, I think I'd like to highlight on the right-hand side that as of July, our weighted average interest rate is down to 3.21%, and our weighted average debt maturity is up to 2.8 years. We now have no outstanding loans for 2020, and indeed, we're already planning for 2021. Our gearing has edged up slightly to 39.1%, and this is mainly due to the change in fair value of properties, not I would emphasize, from additional borrowing. And we've continued to build our financial war chest with a total undrawn facility now of about USD 135 million. On Page 10, you can see that we have a strong balance sheet. Again, I would emphasize that we are paying out 100% of our DI. It's our preference to pay 100%. And unlike some Singapore REITs, who are able to retain and defer their distributions, MUST is not permitted to defer its distributions and must pay out a minimum of 90% of our income as stated in the trust deed. Let's now move on to the portfolio's performance. On Page 12, I think you can see that we have in 2020 and again in 2021, we have minimal expiries due at 3.4% and 5.7%, respectively. It is obviously, at this time, in this moment of turmoil and God knows how long it will last, it's very important to have as longer WALE as possible and as high an occupancy as possible. But I'd just like to remind everyone that, of course, U.S. office is still very different to that in Singapore. Here in Singapore for commercial office, we're used to leases of just 2 or 3 years, and they have break clauses. We also understand that at the moment, because of those features here in Singapore, but not in America, some tenants in CBD are starting to reset and downsize space and also are seeking lower rents. And that's because they can. But in the U.S., the leases are 5, 10, 15 years. There are no break clauses. There are penalties for early terminations. And as a result, there is one area, subleasing, where tenants can, if they wish, offer a space up to external parties. They have to tell us about that. But since the beginning of this year, it's very interesting to note that we have not seen any discernible increase in the subleasings by our tenants. And I think that is a very strong signal about the quality of our tenants. On Page 13, I talk again about the strong leasing momentum and the positive rental reversions. As I said, 220,000 square feet or so of net lettable area in this first half. 50% of that was renewals, 42% was new and 8% was expansions. And those were in these key areas of finance; insurance; professional services; real estate, still a very strong sector; and the growth sectors such as technology. And again, through this leasing in the first part of this year, we had a 6.9 years average WALE, the rental reversions of plus 7.9%, and also, our rental escalations for these particular leases were at 2.4% compared to our average currently of 1.9%. So these are impressive statistics. We've also, of course, got this very diversified tenant base. In fact, if you think about it, we've increased the number of properties since IPO from 3 to 9. And indeed, the trade sectors have increased from 11 to 17. And we've made a determined effort to do this over time as we bought our buildings. And so we have a superior tenant base with 3 top sectors that remain resilient. That's legal, finance, professional services, including insurance. And they have been performing very, very well indeed for us. We've also found that in our particular types of tenants that prior to the pandemic, actually, it was an area where there was already a shortage of labor in the office sector. And so it's not really been as hard hit in the pandemic because, as I say, really, they seem to be the lowest unemployment rate still as we hit the midyear. Also and furthermore, from our top 10 tenants, you'll see on Page 15, these make up close to 35% of our portfolio. And as I mentioned just now, have a long WALE of 6.3 years. Out of 182 tenants that we have in our buildings currently, about 1/3 are headquarters and many are listed, and we have a very large portion of government or similar agencies. Now our third largest sector is retail -- it's made up of retail. However, if you take out Amazon, that is much closer to 10%. And I think it's also worth pointing out, because a lot has been talked and said about retail, that, of course, the 2 tenants that we have, Carter's and The Children's Place are in the specialist area of children and particularly young children rather than the fearsomely competitive area of adult and teenage retailing. And really, children's retailing is an essential form of retailing. I mean children do grow. Of course, we'll be going into the winter season in many parts of America, where they'd be wanting to buy new clothes for the colder weather. And also, frankly, today, children of all ages want to be seen on blogs and on their zooms. They're having virtual parties, and they want still to be seen in the latest outfit. And so I think that it's -- certainly that it's a robust sector. Moving on to Page 16. Another topic has been the softening of valuations. Now since IPO, we have chosen to disclose half yearly valuations. And this was to create greater transparency. In fact, many of our peers disclose just once a year, but we feel it's best practice, and of course, it is particularly important that you know exactly where we are with our valuations at this half year. So obviously, you would have expected to see and as, CBRE, who is our appraiser, has said, market valuation on [Audio Gap] certainly has come into play in terms of lower growth assumptions. And as a result of that, we have seen a valuation drop at this half year of just under 3% -- 2.9%. However, our cap rates have stayed intact, and we very much believe that once a vaccine is found and we get over this surge, this current surge in America of the coronavirus, we'll see valuations reverse, and we're very hopeful of that. In addition, another topic has been rentals and what would happen to rentals during the COVID period. Well, once again, we think that we are particularly well positioned, very competitively positioned. And the reason that we believe this is because for many of our properties, their rentals are -- have -- were before COVID with some 5% to 10% below the market. And so in these conditions, this provides us with a buffer, a buffer against the downturn. So if you're expecting perhaps to get a 10% increase, maybe you'll only get a 7% increase. But the point is that we are not stretched, and we're not seeing -- we're not at market where we might see a decline. Where we have a couple of properties that were ahead of the market, that is most particularly Centerpointe and Capitol, the 2 buildings that we bought last year. That is because they are being compared against a larger market group. And in reality, being the best buildings in the area in both Centerpointe and Capitol's case, we are actually -- again, we can secure or expect to be able to secure higher rents in due course. Turning to supply on Page 18, we can see here some of the areas where there is some availability and some supply. But again, I think it's worth just saying a couple of words about this. Two of the areas where there is supply are in Atlanta. Of course, Atlanta has been one of the hottest markets in America for growth and for many other areas of a booming business. And there has been some properties built in the last year or 2. But I would hasten to add that, for example, in Midtown Atlanta, where there have been buildings built, for example, one of the buildings is 40% preleased to Google. And indeed, there are many other first-class tenants coming in to the buildings. And so we think that we are in a very good position. In terms of our Phipps building in Atlanta in the Buckhead area, we're 100% occupied. And so we're really not affected by any supply even if we thought that it was competitive with us. In Washington, and this has been, I think, a perpetual topic since we bought the building a couple of years ago, there's actually no comparable new supply. The supply that there is, is Trophy. We are a Class A building. And so there's really, frankly, very limited supply. I think the most important point, of course, is that over the next 2 years, it is a very brave real estate developer who actually puts a spade in the ground and decides to develop more property when there is uncertainty around. So I think we're in a very helpful position. So let's move on now to a more general subject. As Carol said at the beginning, let's move on to the future of office, and in particular, starting with working from home. Well, unlike in Singapore and in the rest of Asia, where working from home is a relatively new phenomenon, in the U.S., working from home has been established for as long ago as 30 years. Much nearer term, it's become very, very popular indeed. And Glassdoor, which is an American survey provider, they reckon some 54% of workers in the U.S. are already eligible to work from home. And that might be just once a week, but they are eligible to work from home. So that is a vast number and very different, I think, from the experience in Singapore, and as I say, across Asia. There are other surveys that have been done more recently. So Gensler survey. Gensler are major architects. And they've also found that actually as the pandemic has worn on, only a very few people who have ended up working from home for the first time have really wanted to stay. And there's only really an incremental number of about 2% who now want to work from home where they didn't before. So what may change in terms of working from home and the future of office? And on Page 21, we have really turned this the era of mobility. Again, in America, mobility started many decades ago, not just because of COVID, it's an accelerating trend of some -- to some degree and not something that's new. But with us in the era of mobility, we see the physical office will become a critical component of a hybrid workplace. And this is how we feel it's beginning to pan out. Obviously, your office or in particularly if you're a headquarters, it's the hub that connects all your employees. But what it is that employees want, particularly in America it seems, is the power to choose. It's not the power to work from home, it's the power to work from anywhere. So I can work in Boston today, I can work in Los Angeles tomorrow, I can work from my holiday home or my holiday location, wherever it happens to be. And so it's also very important that we are aware of that and that where we have a hub, where we have a major building, housing headquarters and so forth, that these locations are best suited for that type of tenant of the future and employee of the future. And so we sort of see the office of the future. It will be, as described by some real estate experts in America, the silent partner of a company's brand and culture, that will be the knob of the, as I say, the brand and the culture. It will also be the location that drives the employee connectivity. It will create a chemistry. It will create -- it will be the hub of innovation and entrepreneurialship. And it will still be a place where people will want to go, bump into each other in the corridor and have that moments of brain storming an aha moments that is so essential to all our working lives, and I'm sure everybody on this call knows what I mean. And because, as I mentioned earlier, office was really very, very short of labor, of quality labor before the pandemic, it is going to still be essential post the pandemic that offices provide a competitive edge where talents can feel that it wants to be and it wants to locate to. So your location, your type of office is going to be incredibly important to increasing productivity, to training. I understand that there are all sorts of statistics that are showing that, that trainees are starting to slow down in the way that they advance in their training courses because they're not just being able to suck up that this -- all this new information from the colleague who's experienced sitting next to them. So we think that the era of mobility is very important and very important to the sorts of buildings that we have and the buildings that we may have in the future. And we feel that these trends really have minimal impact from us. And indeed, actually almost the reverse that MUST is in a very enviable position. Because, of course, we have, over the last few years, chosen to be in urban and suburban markets, even the properties in a CBD area such as the Capitol building, which in Central Sacramento, these are very open locations, much more akin to urban and suburban. So we are already very well positioned. And in the urban and suburban offices, of course, you appeal to that trend of live, work and play, you can provide car parking, you can provide a walk to work, and you can provide a very attractive, very open environment. As I said earlier, there's not going to be much in terms of supply. And indeed, in other areas, we believe that there's already -- there's a lot of the big banks and some of the bigger firms are just pausing, whereas perhaps a month or 2 ago, they thought about maybe we should start thinking about moving here or moving there or retrenching. Really now that people realize they are going to have to employ social distancing, and they want to get people back to work for all the reasons given just now. They are going to have to dedensify, hot desking is gone, safe distancing is in. And we also -- if you're going to have people working from home, say, 2 days a week and working from the office 3 days a week, they have to have a designated space. And that means there needs to be more space, not less space. So I think this is very good in terms of the impact for MUST. So looking forward, let's just have remind ourselves where MUST is now in terms of COVID-19. So all of our 9 buildings have remained open throughout the pandemic and remain open now. In terms of real occupancy, we have some 10% to 20% occupied only at the moment. You would expect it to be that sort of a number. I know in other locations around the world, numbers are much higher. But we have to remember that there is a surge on in America at the moment. So I think this is still a very good rate. Even more important is the rental collections that we have seen in the first half and indeed, more particularly, April, May and June this year. We have an average collection in the first half of 96%; and in April, it was 99%; in May 97%; and in June 93%; and we are looking good in July, is what I would say. Rental deferments provided to tenants is a mere 0.3%. And abatement also the same level. So really, and I think we're doing very well. And of course, this is partly because we have been working very closely with our tenants and providing them with the very latest in terms of guidance for COVID, keeping the offices clean and refresh. And indeed, there is more on our Manulife COVID guidelines in the appendix of this particular presentation. So I would urge you to have a look at that. I think we have to just mention just for a second, the U.S. economy. And I would just say upfront, this is not the global financial crisis. This is a very, very short, sharp disruption up to now, obviously, very, very deep. But we have to remember that the banks are better equipped to maintain market liquidity due to their stress testing requirements. Commercial real estate is far less leveraged than it was as we went into the global financial crisis, some very big differences, particularly for some of our buildings, in that respect, our commercial buildings. And there is less oversupply of inventory. Indeed, as we've said many times in REO, there's really no oversupply. And we do expect occupancy to rebound. Now Manulife's Global Chief Economist and Global Head of Strategy considers that there are 3 phases to the disruption. The first phase, the short sharp shot that we've all had over these last few months has been cushioned in America by the Fed package and by the PPP package and the relief budgets. In the second phase, we're in a holding pattern while we wait for a vaccine and while we wait for these surges to pass. But in the recovery phase, we're going to probably see, we believe, a very quick recovery. Now we all saw the GDP numbers, the annualized minus 32.9%, which is -- was better than expected, although I find that rather an amusing topic, but we do expect and certainly, our Economist, our Chief Economist, expects the rebound in the second half. And people are talking of levels of plus 23% for year-on-year or plus 5.5%. I think, again, to put it in its context, I was interested to see one of the major real estate companies put it like this: GDP in 2018 was 2.9%; in '19, it was 2.3%. This year, it may be minus 5.1%; and in 2021, we could see an equal rebound of 5%; and in 2022, more back to normal at 3.4%. And to me, that very much summarizes where we've been, where we're going, and I think that's good and important. So finally, where does this leave us for the second half and beyond? Well, clearly, we are anchored by a portfolio that is built to ride out the crisis and emerge stronger. We've got a good portfolio. We're very well positioned. I don't need to lower the point. We've had tremendous rental collections. And that's because we have these top-quality tenants. And we are busily working on proactive leasing and working to maximize with tenants, their current and their future plans. We're managing the costs. And a tremendous amount of cash management is going on. And again, we've talked about both the undrawn facilities and the potential savings this year and next year from refinancing. But I think beyond this, it's important just to say finally that of course, at some point, we will be seeking more accretive acquisitions in cities with strong demographics and high growth. And we'll be building further resilience through the future direction of our growth. And I think that is very important to bear in mind and to think about as you look towards the future as regards to MUST. We are built to endure and we're built for more. Thank you.

Yes. Aaron, are you there? You can open up the lines for Q&A now. All right. Thank you, Jill. Sorry, there was just silence.

[Operator Instructions] Our first question, Rachel from DBS.

My first question is on what's the -- could you give us some color on the leasing activities on the ground post the reopening? Are tenants starting to come to you to talk about either rightsizing or are they looking to expand more from other cities over to some of the urban, suburban offices? Yes, just some color on that.

Well, I think I'll just pass this over to, Jen, if I may, in a second, but yes, I mean there were people who were undertaking virtual touring, even in the worst of the lockdown in America. But we are definitely starting to see some more activity, quite tentative, I think, and I think that's right, particularly as there's a surge going on. But there's definitely more interest and more touring going on. Jen, do you want to add some color?

Sure. So what we saw basically in the depth of the downturn here which -- or the depth of the closure of the market, which would have been April and May in the U.S., is that there was effectively no leasings. We started to see a little bit more in terms of green shoots. So as Jill mentioned, virtual touring became a little bit more accepted, whereby 6 months ago, no tenant would actually seriously consider doing virtual leasing as compared to visiting the space. But now it's become a more effective tool for people actually making decisions. We haven't seen a lot of actual leasing activity within the markets, but there has been more people kicking the tires and asking for proposals and for rents, sorry -- and for lease availability. In terms of our tenants, we have not had tenants come to us looking to rightsize, looking to downsize, people looking to move in response to COVID right now. It's still seem it's too early to make these sort of long-term corporate decisions when it's really -- we've really only been in the depths of this and coming out of it for the last 4 to 5 months. Remember, leases in the U.S. are 5, 10, 15 years. So people are still taking more of a wait-and-see attitude, and they're still pausing until there's some more certainty. Now it's not paused to 0 but it's still substantially lower than what we've seen before. The good point here is what we've been seeing across our portfolio as well as nationally is the asking rates have remained stable. So there hasn't been a lot of pushback on the rents to date.

Okay. Maybe just a follow-on, any of the top 10 tenants are having expiries coming up soon in the next 1 to 2 years or rent review or break clauses?

Right. So at the top 10 tenants, we do have a couple of them coming up, not in the next -- not in 2020 or 2021. We do have a couple in 2022. But they are long-term tenants of the building, and we will work with them. Obviously, we're expecting COVID to be a distant memory at that time. And then in terms of break clauses, no, we don't have any tenants in the top 10 that have break clauses within the next couple of years that we expect to have them exercise those clauses.

Our next question -- [Operator Instructions] Our next question, Terence Lee from Crédit Suisse.

So with the surge in COVID-19 cases, what is your expectations for the deferments and abatements hit for the third quarter?

Well, I think we're in a very good position. We are in constant contact, obviously, with our tenants. And having risen with them through this first months, I think we've got a very good handle on it. And I think the outlook is pretty steady for the second half. And I think over the next week or 2, we may see that surge abate. This is a holiday period in America as well you have to remember, and people will start after Labor Day to get back to work. And I think at that point, we'll start to see -- and presuming there isn't a third wave, too soon anyway, we'll start to see things improve again. And I think that's what we're looking for into the third and fourth quarter.

And I would just add to that, even in the -- sorry, just to add on to that, Terence. So even in April and May, which saw a lot of the U.S. actually shut down, we only exhibited very small amount of deferments and abatements of 0.3% each. And I'd also say that there is very little political will and public will to actually go to that extent of shutting down the economy. So it's more pushing people to actually wear mask, stay 6 feet apart, reduce the large gathering versus the actual shutdown of the economy, which we saw. I think there's going to be a very low probability, obviously, in the absence of a huge spike in cases, which we're not expecting of that actually happening again.

Okay. So in other words, 2Q is the worst that's been so far? And I just have a...

Well, I think -- I mean, unless you've got a big crystal ball, you never say never. But obviously, we do believe that the U.S. authorities and indeed, U.S. individuals have -- well, have it under control. So -- and we -- as I say, we have worked very extensively with our tenants, and so we know where their financial position is. And obviously, we hope it won't get worse. But you could even say absolutely never. But yes, so it looks steady. And let's say, July, is looking pretty reasonable. So...

And on Slide 32, I see that the 12-month projected rental growth by, I believe, it is CoStar, it's appearing pretty positive, I would say. Just wondering if this is something we should use as our benchmark for rental growth going ahead?

Well, we'd like to think so. Jen, would you like to add?

Yes. So this is obviously a 12-month rental forecast from the beginning of July. And again, most people in the industry think that this is going to be a very short-lived phenomenon of 6 to 9 months, maybe. So we are expecting to see growth in -- continued growth within the down -- or sorry, within the markets stated here. As Jill mentioned, compared to the GFC, there's not a lot of supply within the market, and they're expecting any new supply that was planned to not actually come online. We have long-term leases and less leverage. So we're expecting for most of the landlords and the tenants are in better position to recover from this quicker. And hence, you're seeing the supply/demand dynamics work here where the demand is going to hold steady or go higher and then supply is going to either level off or go lower.

Our next question, Michael Lim from UBS Securities.

I've got 2 questions. The first one is on the rental collection that you mentioned. So you've got April, May and June numbers, they seem to be coming down. Can I inquire as to whether they're the same tenants who were not paying over these months?

So I would just say over April, May, June, what you're seeing is not so much of a trend going down, but more tenants taking a little bit longer to pay. So they do end up paying as you can see by the 99%, that we've seen in April as well as the 97% in May. We do expect the June numbers to reach somewhat near those numbers, but it's more of a function of time than a function of a declining trend.

Okay. And my next question is on the green loan, which you acquired, and you mentioned the interest rate was 1.85%. What would a standard loan cost?

Robert?

You're referring to the margin?

The -- well, on a like-for-like basis.

Well, it's hard to say. I mean this is a 5-year tenure. It comprises of the margin and the swap rate that we locked in the cost. So we're fortunate that we managed to secure the swap at a fairly low end of the curve. As you know, the interest rate environment has come down quite sharply. So we managed to pick up the swap at the bottom of the range. Not the lowest, but it's fairly low as it stands now.

Had it been a standalone, what rate do you think you'll be able to get it at?

You mean the margin?

I'm just trying to understand the motivation to get a green loan?

I think, Robert -- sorry, Michael.

Well, I hear what you mean. I mean there is actually no distinction in terms of pricing between a green and a traditional conventional loan. That's your question, right?

Okay. Right. Okay. Yes.

Yes. I think that's Michael's question, yes.

Sorry. My bad. Again, got it.

No. No problem. Yes.

Our next question, Vijay from RHB.

Maybe just 2 quick questions. Firstly, on the leases -- leasing structure, leases signed. My question is, has there been a change in the tenant's approach in terms of leasing? Are they asking for a shorter lease compared to probably 5 to 10 years? Is there more TIs, which the tenants require for extension or is there a flex kind of structure, which you see in the leasing post COVID-19?

Well, there hasn't been anything on the -- really of that sort on the leasing that we've achieved in the first half of the year. But I think it would be unrealistic to believe that people aren't going to, a, try it on with their leasing. So maybe there will be some more TIs. People will, as I say, I think, why not you would ask for what you could get, wouldn't you? But so far, we haven't seen anything of that sort. Jen, do you want to add anything on to that in terms of your outlook for the second half?

Yes. No, I'd just agree with Jill based on the supply-demand dynamics, it's not really -- we're not really expecting tenants to be able to ask for things that are well outside the market norm as we're seeing them today. We saw that in the first half of 2020, where it was very standard. In terms of the TI though, that's something that's been increasing over the last 5 years. I would expect that to continue to go up, not at an exponential rate based on what -- based on COVID, but I would expect that to go up slightly, marginally as time goes on. In terms of shorter terms, like our, yes, lease -- weighted average lease term for new leases, was longer than our 5.7 years. So we're not seeing that.

Okay. Okay. Got it. And second question is on valuation. I see the valuation changes especially the Penn valuation has declined by the largest about 5 percentage. I thought this building is anchored by U.S. Treasury and U.S. exchange. Is there a risk that the tenants would drop off at the end of the lease term? Is that what values are assuming?

No. Yes. So sorry, the short answer to that, I would say, is no. So what we're seeing in Penn is -- well, what we've seen across all of the buildings in response to COVID, we've seen the decrease in the market rent growth, whereas appraisals in the U.S. were made up of 3 different valuation methods, sales, tariff and direct capitalization, discounted cash flow. The DCF method typically carries the most weight. And therefore, the market rent changes will impact value. And that's what we saw across the board, it's the primary reason for the value decline in all of our buildings. However, in Penn, there has not been any assumptions of any tenants leaving. You're right, we do have large government tenants, and this is more tech -- or it caters more towards the government-type buildings, which are the solid credit tenants that you would want in what's happening with the COVID situation now. What's happening with this particular building is the expiries of some of our larger tenants are getting closer to today. So as we move forward in time, the expiries come closer, which will impact value and so you renew a lease.

Maybe Jen -- Jen, this is Carol, sorry. This is Carol. Jen, I think you explained very well, like internally through, like, the assumptions that was used by the valuer this round on the rent growth, I think from year 0, year 1 and what has really caused the decline and how that happened? Because I guess, at the back of analyst's mind is, if our occupancy is so high leases rolling in 2020 and '21 is that minimal, how could the impact actually come through? So maybe you can just give a bit more color to the analysts, so I don't have to take that on later.

Sure. I'm happy to help and talk about appraisals as long as everybody likes. So like I mentioned, the discounted cash flow method typically carries the most weight when it comes to the value professional judgment that appraisers use between the 3 methods. Now with the discounted cash flow that's typically done on a 10-year basis. So what the appraiser does is they slot in the actual leases over that 10-year period, however long they may be. And then there are the market assumptions, which are the market rents, the market rent growth, TI, leasing commissions, how they might change over the period. And those kind of run in the background of the model. So when a tenant lease comes up, it will roll to the market assumptions. And what happened here just mathematically over a 10-year cash flow is that the reversion value actually carries a lot of weight. And by a lot of weight, I mean about 60% of the value comes from that 10th year cash flow when it's present value to today. So 40% is the cash flow over that 10-year period, 60% is approximately the terminal value. So when you make changes to anything that's going to hit the terminal value, which is mainly the market assumptions and the market rent growth assumptions, you're going to see out -- not an outside, but you're going to see more of an impact than if you had changed a tenant lease that only impacts 1 year. And in terms of what we're seeing and what the appraisers have done, basically, across the board with a lot of office assets that are well leased -- on the tenant there are paying rent and such. So there they are the core stable properties. What they've done is they've changed the market rent growth assumption. So previously, over that 10-year period, they would choose the market rent, and it would grow by 3% every single year. So year 1 is your market rent, year 2 it's the market rent at times 1.0%, year 3 your growth. And the only change they've made here is move the year 1 rent to -- rent growth to 0. And that has the impact that we're seeing here of the decline of just shy of 3%. So which is why we would expect when we see a little bit more certainty and resolution to the COVID pandemic that the valuations will revert and when you see a vaccine, then they definitely will revert as that market growth trend goes back to normal. So that was a bit long-winded, so I'll hope that's what you were looking for, but that's basically the gist of it.

Thanks, again.

Sorry, it took a lot of your time.

Yes. No worries. Okay. Got it. Because my question is because there has been -- there seems to be some deviation between what CBRE is forecasting and CoStar is forecasting. CoStar is forecasting still a bit of rent growth, but CBRE is forecasting a rent decline. So is that because there -- is there some difference between valuer's assumptions or difference between valuer's themselves? Is that causing the valuation decline? That's something I'm trying to understand because...

Yes. You're not going to really be able to marry one like CBRE or any appraiser's growth rent with what we're seeing in CoStar because they both would have 2 different opinions. And the appraisers take more of a long-term view. They very, very rarely isolate years growth. Usually, they just pick one, like a 2% growth, 1% growth, 3% growth and run it through the whole model versus what we're seeing in CoStar, which is just a 12-month reading for that. So they take more of a -- the appraisers take more of a long-term view and they smooth out the rental increases versus what we're seeing here. So the CoStar leases you would expect to be reflected in the market rents going forward, not so much in the market rent growth.

Our next question, Derek Tan from DBS.

My question is on Slide 16, again, on valuation, if I -- don't mind, just wondering whether the reflection in expansion in cap rates. Are we seeing any notable transactions in the market that suggest the similar trend? And also going forward, in terms of acquisitions, would that also guide us on where potentially you'll be looking to buy an expanded cap of about maybe by 0.5 bp and anything? Yes -- 50 bps and anything, yes?

Sure. So in terms of transactions, there has been very little transactions that have occurred with the market. And basically, what's happened here is that we've seen like basically a freezing of the market as everyone is holding their breath to see how the crisis will shape out. So this results in a wide bid-ask spread where no seller is willing to sell for anything less than a pre COVID price and no buyer is willing to buy for anything more than a COVID discounted price. So as a result, that thing is really traded. So as we've seen in previous downturns, most investors will take a wait-and-see approach. And then as there's some more clarity on underwriting assumptions and economic outlook, we would expect to see some -- the trade start to pick up. Now that said, there has been a couple of examples that I'd like to give you here. So the best example of the impact of COVID on institutional quality properties is an office property that traded in Chicago. So this would have been a Class A office property. Now all the properties that have traded within Q2 came to market in Q1. So it's typically a 3-month process to buy buildings. So this property in Chicago underwent contract -- went under contract, sorry, before the quarantine and it closed in May, and they were able to get around a 4.5% discount to the original purchase price. So that's the -- pretty much only data point that we have for a building transacting and the discount. However, I would say that every property is unique, every market is unique and the broader trends impact the value of the property, but they're not the only factors impacting value. So Chicago, for those who are not familiar with it, it is one of the largest cities within the U.S. However, it is very developer-friendly. So there's buildings and supply going up all the time, which could impact the price. Another data point I'll give you is a building in San Diego. So again, the same circumstance, the property went under contract before the quarantine. The seller during COVID said that they wanted a 2% discount, so less than half of what Chicago was, and the seller said, no, and it fell out of contract and it didn't trade. So across the board, we're seeing a couple of things happening. The big thing is it's all building and market specific. The second one is, we're not seeing major distress in the market or people or sellers accepting lower prices.

Okay. My next question on Slide 17, if you can provide us a bit more input will be on Michelson and the Centerpointe, I mean that's always done very well versus the market. I'm just wondering whether should we reset our thoughts about your -- the property's ability to command the kind of premium versus the market given the fact that markets potentially may weaken? Yes.

No. So I would say it's all relative. So in terms of Michelson, it really is only 3 Trophy properties. So these 3 properties within the Irvine submarket here stand by themselves. So we do not expect -- we expect to see maybe a little bit of the rent movement, we haven't experienced that yet, but it would impact Trophy and Class A. It wouldn't really tighten the 2 from what we would expect in the short term. And the same with Centerpointe. Centerpointe is one of the best assets within that market, which is why it's able to command a higher rent than the market because it's really only competing with 1 or 2 other buildings to a tenant. So we can push it by a few dollars. Again, the rents we haven't seen any rents come off yet in terms of actual value, but we wouldn't expect -- like they're still the best buildings, what we're actually going to see in this kind of market is more -- there's quite quality where more people would want to be in the back building, so we will still have some of that ability to push our prices above the market. Now I'm hoping it'd likely shift down, but we haven't seen that yet.

Our next question, Rachel from DBS.

Sorry, I got cut off just now, but yes, that's fine. My next question is actually on the tax. I see that in first half, there's a positive tax number. I'm just wondering whether is that due to the valuations? And would that reverse up when there's a change in valuation?

Yes, that's correct. I mean -- well, you see a tax income. That's basically a reversal of the tax provisions because of the tax losses, I mean, fair valuation losses that we recorded in the first half. So again, if the valuation picks up in the second half or in future periods, this will be adjusted accordingly.

Okay. Got it. And my second question is on the Atlanta market. I see that it has dropped to a negative net absorption. And I presume that could be partly due to the Google lease that was removed, I'm not sure. But any color on the Atlanta market, whether there's any risk in terms of vacancy?

Well, I think I said earlier that certainly, in terms of our buildings, obviously, the Phipps building is 100% occupied, and also our Peachtree building has a very, very high occupancy as well. So from that point of view, we're in an extremely cushy position. But I think that overall, there is still just huge demand for Atlanta for all the reasons prior to COVID, I think will still apply as we work our way through the COVID crisis in terms of the attractiveness, the growth of the population, the diverse nature of commerce and business growing in that respect. It's live, work, play environment. It's still a very, very attractive city capital at the Southeast of America. So I think it will remain just as attractive as we work our way out of the crisis as it was before. And actually, if anything, it's the success and attractiveness of Atlanta that had created the interest in building more buildings. And clearly, there were plenty and there are plenty of tenants to fill them. And now, of course, not so many might be tempted to, as I say, put the spade in the ground. So actually, we're possibly in an even better position in terms of supply were start to grow again, and I think you'll probably see some very good stats. Jen, do you want to add some color?

Yes. I would just say that when we look at our markets, we look at them more on a long-term trend versus what's happening quarter versus quarter. So we wouldn't make any sort of decisions on cities or how they're doing based on 1 quarter and especially not Q2 2020, that will be an anomaly across the board. So it hasn't changed our opinion on it, as Jill mentioned.

Our next question, Nirvaer Sidhu from JPMorgan.

The first question I have is in regards to the NPI. Obviously, you had a very positive rental reversion. But I noticed some properties NPI has dropped partially due to occupancy. Going forward, do you have any thoughts in terms of any increases in vacancy risk for your portfolio? Second question in regards to work from home. Your portfolio doesn't have much technology clients, but in terms of overall Manulife of -- for the U.S., are you seeing more pressure from the work from home impact?

If we might start with the last part of your question, Nirvaer, and I couldn't quite hear all of the first part. So let's just tackle the work from home. Certainly, we are not seeing, as I said, at the moment, it's too early to tell, but we are very confident that given that work from home is such an established way of working or in the U.S. and there seems to be gathering evidence that people are actually -- I think that's quite a good article in the financial times today about the blues of working from home. And certainly, as I said, as Gensler's statistic suggests that there's a very small incremental increase in working from home. And anyway, if we end up with a hybrid going forward where a few people -- more people work from home or employers as we work our way through the last part of the COVID crisis maybe once there's a vaccine that you're working 3 days or 2 days from home and 3 days or 2 days from the office, you're still going to have to have the same amount of space. If anything, you've got to have more space for those big banks and other major financial companies that maybe were hot desking, now you're going to have to actually provide more space, and you're going to have to have designated seats. So actually working from home is not just a simple complex, so as you know not everybody work from home, it might be for some of the well-known tech companies, but whether they'll even do that in the longer term, it's very debatable. So I think from a work from home perspective, once people feel confident to get back into the office, and we start to see those real numbers of people being in the office perhaps get back up to about 50%. I think it's going to be interesting to see how the picture is, but we don't see any decline, if anything we see people wanting to have more space. And Nirvaer, could you just repeat your first question again?

Sorry, I'm in the office, I'm forced to wear a mask, so I'll -- we couldn't take it off. Yes, just in terms of the -- maybe it's a question for Jen, just thoughts on vacancy risk going forward. Because you've had these positive rental reversions where some properties still saw a decline in NPI. I don't know whether it's just purely based on accounting or on a cash basis, it actually is up, but your thoughts on occupancy risk going forward?

Yes. So just on the vacancy coming up in the next like a 6, 12, 18 months. So we have very little rollover happening within that time. So you can see over the period, we have less than 10% rolling. And we do not expect any sort of major increases or even like significant increases in the vacancy of our properties. We obviously believe in the strong ability of these properties to attract tenants, retain tenants. We do have the buffer in terms of where the leases are versus where the market is. So we would expect to see flat to single-digit in terms of rental reversions continuing. I expect the leasing process to be lower as tenants make decisions. But really, what we're seeing is the people who are renewing are the ones that are obviously forced to make decisions, and we haven't seen anybody make a decision based on COVID, like at all or make a decision to leave because of COVID. So I'm confident in not seeing any sort of major increase or increase in a significant way in terms of the vacancy. And then just as a little point on your second question there. In Jill's question -- or sorry, Jill's -- in conjunction with Jill's response, just as an example, I've been a mobile employee for the past 5 years within Manulife, and I have the ability to choose where I go, and I choose to go to the office every single day. So nothing for me has actually changed with this COVID because there's about 30% of us in the company who have this ability. So I still go to the office every day.

Our next question, Nicholas from Crédit Suisse.

Just had one question on the de-densification trend. Do you guys see this, I guess, from talking to tenants or any sort of anecdotal evidence you have on the ground so far? Do you guys see this as a longer-term trend or it's something that could be more so short-lived while we had COVID around and once we get a vaccine or something in place, then we continue to see hot desking being viable, and we still have very dense office spaces?

Yes. Well, I think, again, it's very early days as yet. And there's a tremendous amount that's been written all over the world about this subject. There clearly is -- once a vaccine is found, of course, that could transform everything and people actually may decide to reintroduce hot desking in some form. And in fact I saw an article about that only last week, I think that's a bit premature personally. But I think that there still probably will be a trend. And I think this is exciting for us, given where our buildings are. I think one of the things that one of the lessons that has been learned is that perhaps CBD in Manhattan, CBD, San Francisco, CBD Chicago is perhaps maybe if you're thinking to locate, you're going to probably think again about whether you might want to go to somewhere that is much more urban and suburban. And again, it comes back to the live, work, play, what people are comfortable with, whether they want to take public transport or not. So I think this has not played out by a long way. But certainly, there are hints that we see that the big firms are definitely where they were thinking about maybe taking or looking for a building as I say, in a more suburban or urban setting, they're perhaps just looking a little bit harder than they were. But there's nothing definite at the moment, but there definitely seems to be some sort of trend towards that. And that's obviously extremely good for our buildings, and certainly, ultimately for their valuations. But then that will make it more competitive for us, of course, when we get back into our accretive mode. So our growth mode and looking for accretion and all the rest of it. But that's healthy. That's good. That's what makes the market.

Our next question, [ Dhillonvardhan ] from [ The H ]

I'm just wondering, back to the valuations, I understand that Jen said that DCF carries more weight. But with the transaction of U.S. Bank Tower, which was lower than expected, have any impact on Figueroa in terms of cap rates or anything like that? That's the first question. And the second question is there appears to be a bit more of a conservative in terms of rental growth. How does that compare with Jill's view that there could be a strong rebound in the U.S. economy in the second half. Because the news coming out of the U.S. appears to be that COVID isn't under control. They've had more than 155,000 people dead and 3.5 million affected? Yes. So those are the 2 questions.

Sure. So I'll take the first one on Figueroa. And again, the short answer to that is no. So the U.S. Bank Tower, although the headline said that it was sold for substantially below what it was worth or what it's on the books, like that building has been on the market for more than a year. And when they came out with the value they were looking for, the owners, like nobody was going anywhere near that. It's not a building that's worth $700 million that was kind of an outrageous price. So what's really happened is the building traded more at where it should have. Now remember, this is a building that has less than 80% occupancy in it. It requires a lot of capital in order to be able to get the leasing up to what could be a stabilized rate for that building, which might be around maybe 85%, 90%. So when the valuers did a rollout it did not impact their investment metrics for our property because we do have, obviously, the long-term leases, we do have a lot of strong tenants. We do have a much higher occupancy rate than the U.S. Bank Tower.

Thanks, Jen. That's the answer to your first part. Yes. Yes? [ Dhillon ]?

Yes, yes. So the question on the -- you've got a more upbeat outlook in the second half of the strong rebound in the U.S. economy, but the appraisals seem to have assumed lower rental growth and all that. They appear to be a bit more cautious?

Yes. Yes. And I think that's why -- yes, they would be. Certainty at the time when they were engaged in their appraisals, which remember now is effectively a couple of months ago. As I said, that phrase about market uncertainty, I think was clearly uppermost in their minds. However, they are working off facts, plus, if you like, the qualitative judgments of market uncertainty. And of course, right now, we are going through, as you quite rightly say, we are going through a very tricky patch in America. I think that's a British understatement, by the way, in terms of -- obviously, we have seen this huge surge and across a much broader range of America, not just the major cities, but obviously out into more urban areas than suburban areas and out into countryside across America, a much greater sway. But we do expect, obviously, over the next weeks, as I said, we expect that, that will calm. And then hoping that all the signs are that, as I think some of the medical experts in America have said, there is room for cautious optimism on a vaccine possibly the fourth quarter, beginning of next year. Certainly, we see that as people settle and things settle down, that there is room for quite a sharp rebound. Not necessarily all the way, as we were suggesting. But certainly, there could be a very reasonable reversal. And so that's why we still remain optimistic for the second half.

As there are no further questions, I will now hand the session over to Carol. Over to you.

Thanks, Aaron. Thanks, Jill, Jen and Robert. Okay. Now we have come to the end of the briefing. So if you have any further questions, please feel free to drop me an e-mail or WhatsApp or Blendr, if you feel so. And if you have your reports ready to -- remember to send it to us. We just thank you for all your time, and I think we were trying to cover as many questions as possible. So we have to run for our 10:30 group investor meeting with about 60 investors. So if we were a bit slow to answer any queries, just ask you to be patient with us. So with that, have a great start of the week and take care and stay safe. Thank you, everyone.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.