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

Good morning, everyone, and welcome to Manulife U.S. REIT FY 2023 Financial Results Briefing. My name is Wylyn, and I'm from Investor Relations team. This morning, we released our full year 2023 financial results. So all the results materials can be found on the SGX website as well as [ our corporate ] website. So please note that this session is being recorded. The recording will be made available on our corporate website after this meeting. So today, we're very happy to have media representatives joining us in person, and online, we've got more than 200 participants joining us via the Zoom webcast as well. So today, we have our management team here with us as well as our Chairman, who has flown in from the U.S., join us. So let me do a quick run of introductions. Starting with the manager, we have our CEO, Mr. Tripp Gantt; our Deputy CEO, Ms. Caroline Fong; our CFO, Mr. Robert Wong; Head of Finance, Choong Chia Yee. Dialing in from the U.S., we have our CIO, Patrick Browne. And of course, our Chairman is here today with us, Mr. Marc Feliciano. So thank you very much. We will start with the presentation by Tripp, and then thereafter, we will open for Q&A. Okay. So I hand it over to Tripp.

Thanks, Wylyn. We'll make this relatively quick because I know we want to get to questions as soon as we can. We'll start on Page 5 here. The big news in the second half of this year, obviously, was the recapitalization plan, the restructuring that we negotiated with our lenders. That was approved by unitholders in December. And really, the top story of that is that it allowed us to get a waiver of the breach of our loan covenants. They extended our debt maturities and also temporarily relaxed the loan covenants to give us a little bit more space to be able to operate as we move forward. I won't go into the details of the numbers here, but the financial and portfolio metrics are all things we'll dig into in a bit more detail here in the slides. The 2023 financials. The gross revenue and net property income, you can see we're actually up year-over-year. The calculation for the distributable income, however, on a full year basis was down about 15.5%, largely due to lower rental income, higher expenses, both at the property level and higher borrowing costs as well as the divestment of our Tanasbourne asset in April. The loss of that income had an impact on the DI as well. Now I think everybody is aware that we are -- that we have temporarily halted distributions as a result of the redefined -- restructure with the lenders. We will be halting distributions until the end of 2025 or until we are able to meet the early reinstatement conditions. Now the early reinstatement conditions are essentially if we get below the MAS gearing threshold of 45%, we'll be able to resume distributions at that point. But until one of the response terms was hit, we will not be making distribution. Looking at our net property income. It was up slightly in 2023. But if you noticed, that was largely from termination fees that we received. I guess it's the silver lining in some ways about some early -- some tenants who exercised their early termination options. We had $9 million of these termination fees in exchange of $4 million at Plaza. Otherwise, without these termination fees, the -- because of the lower rental incomes, higher property operating expenses, that NPI number would have been lower in 2023 if it was not for these termination fees. Our investment properties and total assets have declined somewhat, largely as a result of a combination of 2 things. The divestment of our Park Place asset to our sponsor, $98.7 million, and the 8% portfolio valuation decline at the end of the year, obviously, brought those numbers down. Our borrowings also went down as we used that $98.7 million proceeds to pay down our loans in addition to a small $9 million payment that we made in August, shortly after the breach of those loan covenants. Together, the NAV has declined. The NAV per unit is down about 17.5% from $0.40 at the midyear to $0.33 [ this year ]. The debt profile. As I mentioned, all of our debt maturities have been pushed back by 1 year. So when you look at the blue bars here in this chart, you see that we don't have any debt maturing until 2025. May of 2025 is our first debt maturity now coming up. That orange bar under 2024 simply represents the last step of the first part of this recapitalization process, which is the repayment of an additional $50 million of debt from cash on our balance sheet, and that will be made at March 31 this year. The other thing to point out here is really the value of having these covenants relaxed. Our previous unencumbered gearing ratio was -- limit was 60%. As part of the restructuring plan, that gearing ratio limit has been extended up to 80%. And the bank ICR has been lowered to 1.5. So even with the property valuation of 8% and the unencumbered gearing ratio going back up above 60%, we still have a good amount of buffer in the constraints of the loan covenants there. Now the MAS aggregate leverage -- and keep in mind that the bank's unencumbered gearing and the MAS gearing are calculated slightly differently. The MAS leverage takes into account total assets in that denominator, whereas the bank's unencumbered gearing only takes into account the value of the properties. So that's why they're a little bit different. The MAS aggregate leverage went up to 58.3%. I think we were at 56% in the third quarter, again, largely as a result of the 8% decline in our valuations at the end of the year. Our MAS ICR remains at 2.4. Since it's below 2.5, our MAS gearing limit technically will be 45% going forward. The other thing to point out here is the fixed rate loans went from 69.2% in the third quarter to 91.3%. And essentially what that is, is as we paid down debt, our hedges remained in place. So a larger proportion of our debt stack is under those hedges. It has a fixed rate to it. Next few slides. It was a relatively good year for us in leasing, and we're encouraged by this. The 740,000 square feet of leases that we signed in 2023 was almost a little bit more than -- or almost double of what we signed in 2022. The leases have had relatively long terms, which has helped us increase our WALE back to 5.0 years. And we saw some pretty healthy rental reversions, too, on the year at 8.2%. But I think the story here is that we're encouraged by the momentum that we're seeing in leasing. We executed several leases in the fourth quarter, and that momentum kind of carried over for us through the first quarter of this year. Just in the first few weeks of 2024, we managed to sign another 150,000 square feet of leases. And so while we're going to try to keep that momentum going, I think what we're encouraged by is just the amount of activity, what we call active tenant requirements. So the number of tenants who are actually out in the market now, looking at space, touring properties, has increased quite a bit. And it's usually about a 2- to 3-quarter lag between when we see that increase in leasing interest and activity at the property level to when those leases end up being signed. So we're seeing some good signs and momentum in terms of leasing interest as tenants begin to get their mind around how much space they actually need, and they're beginning to feel more confident in making those decisions. The leases that were signed in the fourth quarter. More than 2/3 were new leases. But on the year, roughly 3/4 of our leases signed were renewals of existing tenants. While our lease expirations remain relatively well spread, you can see this year, we've got a lot of work to do. The reason on the 2024 chart for the 2 different colors, in the past, in the way that we've reported it, leases that expire on the 31st of December are usually lumped into the following year. And we felt like it's skewed a little bit how much work we have to do here in 2024. So we broke it out differently. We actually had quite a few leases expire on December 31, the biggest of which was TCW, which is one of our largest tenants, 188,000 square feet of our Figueroa property in Los Angeles. But overall, we still, again, have our work cut out for us here in terms of the amount of leasing that we need to get renewed here in 2024, 18.5% of our net lettable area. We've been making good progress on this. We've also seen some good momentum here. I'll touch on it on the next slide in just a moment. But over the next 2 years, we're really focusing on getting these tenants to renew, and we're being very active in that area. On the next slide, in our top 10 tenants, we were pleased that we were able to get 4 of them either renewed or extended. And we're actively engaged with 2 more right now that expire in 2025. Number 6 and 7 there, you can see U.S. Treasury and Amazon. They expire in 2025. We're actually actively engaged with them at the moment to try to get those renewals executed. The William Carter Co. at our Phipps property in Atlanta renewed until 2035, as did Kilpatrick Townsend, #8, also renewed at our Peachtree building in Atlanta through 2030. Quite a healthy general diversion for us. The Children's Place, #3, at our Plaza property in Secaucus, New Jersey, just recently renewed. They'll be in the building now until 2037. They did downsize significantly from 198,000 square feet to about 120,000 square feet. On the other side of that, though, #5, Hyundai Capital at our Michelson building in Irvine, actually came back to us again with more expansion space. And their lease runs through 2030. And we're really happy that they've been pleased with their building and are kind of doubling down on their space. So that's a good sign as well. Looking at the valuations. As I mentioned, our valuations at year-end were down by 8%. And you can see the headline here is that the Tranche 1 assets contribute to about 50% of that valuation decline. When we talk about Tranche 1, as part of the recapitalization plan, our assets were tranched into Tranche 1, Tranche 2 and Tranche 3. And really, the way that they were broken out was by quality, if you will. The Tranche 1 assets are the ones that we and the lenders together felt that had the highest occupancy risk, might have the hardest time being competitive for demand over a long period of time. They have high CapEx requirements and a relatively low total return potential as we move forward. The Tranche 2 assets, though, on the other hand, are assets that we feel can be more competitive, have perhaps a few -- a little bit less CapEx requirements and have more return potential in terms of the investments we make in those properties. And the 2 Tranche 3 assets, Michelson and Phipps, are our newest buildings. They're the highest physical quality buildings in our portfolio. They're the ones that we feel have the most inherent competitive advantages in their submarkets. And as values begin to recover and the U.S. office market begins to recover, we feel that these assets will be kind of on the lead edge of seeing those valuation increases. And so the Tranche 1 assets were down, on average, about 14%, which was more than double what Tranche 2 and Tranche 3 were. It really just shows that what went into these valuations is the same things that we've seen in the past, higher discount rates, higher terminal cap rates, but also just assumptions in the underwriting about higher vacancy levels and the cost that it's going to take to keep these buildings leased really had an impact on those Tranche 1 assets. And so I think that moving forward, again, as we look at the valuations, our -- the indices that we look at across the U.S., we're roughly in line with those indices. The NCREIF Office Subindex, which is an index that we feel closely reflects the portfolio we have, was actually down 11.7% over the second half compared to our 8% drop. These are charts, I think, anybody that's been following us for a while will have seen before and be familiar with. This is a proprietary research that JLL does for us in our submarkets. And this is not nationwide. This is specifically for the submarkets where our properties are located. At the top left chart, you can see the leasing volumes, while they're still relatively low, are picking up a little bit. And again, I think that is anecdotally, the evidence that we're seeing on the ground gives us some encouragement that we're beginning to see some momentum build here. Concession packages are still relatively high, though. It is still an interest market for sure. The number of months of free rent has picked up as have the TI allowances. If you recall, over the course of 2023, we saw those TI allowances beginning to moderate a bit. And we saw the slight uptick in the fourth quarter. Now the slight uptick appears to be in line with the inflation on construction costs in the U.S. And construction cost inflation in the U.S. has outpaced general inflation by quite a bit, largely because of labor costs. But the uptick in that TI allowance is roughly in line with those -- with that inflationary increase. And where these concession packages really kind of -- where that kind of meets the road here is in that chart on the top right. It shows the difference between the base rent and net effective rents. We're pleased that, that number -- or that those 2 lines are staying kind of at the same point together in terms of the net effective rents. And hopefully, over the course of the coming quarters, we'll be able to see those lines come closer together. Lastly, the sublease space in our market is beginning to stabilize. Again, we're kind of at all-time highs in terms of sublease availability in the U.S. In our submarkets, the sublease space available has actually declined a little bit. It is showing a trend of moderating. Across the U.S., it's continued to increase, though, and again, is at all-time highs. A couple of ESG highlights here. The thing that I'll point out is that on the far right here, we've really tried to maintain an engagement with our investors, with our analysts, with you all. It's been a year of tough news for us, but we've really tried to stay in front of you, stay available and accountable to you, and we'll continue to do that going forward. And so again, it's great to have you all here in the room today. We're going to continue to do these kind of events to maintain open communication, and we'll be available for everybody to answer questions. On the U.S. economic outlook. The GDP growth is slowing. Inflation is still a bit above the Fed's target rate of 2%. Unemployment remains healthy. But I think what we're really focused on is that -- are those federal funds rates and not so much the rates themselves. I think a lot of the market has accepted that we are in a higher-for-longer kind of scenario. But really, what we're looking for here is for the Fed to indicate to the market that we're done. We're stable now, either the rate cuts, the rate hikes, whatever it is. I think that the market, again, had broadly expected that we would see some rate cuts here early in the year. The Fed has signaled that those rate cuts are probably not going to happen until later in the year. And so this instability and this uncertainty remains the biggest obstacle for banks getting back into lending in the U.S. office space, in the U.S. commercial real estate in general. And until those banks are back in the market and there's a functioning healthy and stable debt market, no matter what that rate is, transactions are going to be slow to occur. And that price discovery and that bid-ask spread that we have between sellers and buyers is going to remain. So really, we've said it before in past quarters. This is the thing we're looking for, stabilization of interest rates and a normalization of lending markets in the U.S. really -- to really give us the indication that we're on the road of recovery in the U.S. office market. The recapitalization plan was a very tough negotiation. Obviously, we had 12 lenders plus our sponsor-lender. As you can imagine, aligning the interest of 12 different lenders over a short period of time was an incredibly difficult task to undertake. But we were pleased that we were able to get through that and announced that recapitalization plan in November. After a really wide-reaching roadshow to investors, analysts and media, we were able to get support for all 3 of the resolutions at our AGM. And we're very, very grateful to get all of those passed. Next slide. And so really the pieces of that -- the key pieces of that recapitalization plan. The first one we've completed, the disposal of Park Place to our sponsor for the $98.7 million. The second part was putting into place the sponsor-lender loan of $137 million, which was used to pay down existing lenders, but it does remain as -- obviously as debt on our balance sheet. And really, what we got for that was the waiver of the breach, the relaxation of the covenants and the extension of the loan maturities. What we're focused on now, the next step will be to pay down that $50 million in March, which should reduce our pro forma guarantee to 56.9%. But really what we're laser focused on at the moment and our top, top priority is really focusing on asset dispositions and trying to maximize the proceeds, not only so we can pay down debt, but so that we can have ability to be able to invest and maximize or optimize the rest of our portfolio. We have started the process, and we are targeting asset disposals of about $100 million in the second -- by the second and third quarter of this year. Really, other than that, we're focused on, again, maximizing the operations and the income of our remaining assets, looking to be very, very prudent on our spending, limiting where we can to essential CapEx and just focus on managing that liquidity so that we can be in a position to address maturities and capture opportunities moving forward. So I'll go ahead and stop there. For the folks online here, we do have some questions, some of the top questions we've received from investors. But I think that we'll go ahead and open ourselves for questions from all of you [indiscernible].

Thank you very much, Tripp. For the Q&A session, we will give priority to the media participants who's joining us here today. So for the media reps here, please just state your name and your organization before you ask your question so that our online participants know who is asking the question. [Operator Instructions] If they are not answered, we will try and get to them. But otherwise, we'll get back to you separately. All right. So yes, happy to take the first question.

So just a few questions. So first is just I know that these are the latest valuations, right, the Tranche 1 of around [ $378 million ], which gives you a cushion about $50 million a year. So how realistic are the markdown valuations from last year? And perhaps based on the consequences you've had here so far, have you had any interest for these assets? If so, what is the price action close to the valuation that was started last year?

As I mentioned, we're still in a market where transactions are not happening. I think your year-to-year 69% transaction volume was down about 69% year-over-year. And those conditions to kind of loosen up the sales market remain challenged without lenders in the market. So there aren't many transactions happening. We are beginning to see some of things being on stock. We're beginning to see some buyers, especially buyers -- all cash buyers, taking advantage of good buying opportunities right now, and you see that a bit more. The initial indications that we have on some of our properties are promising in terms of being able to get disposition values at -- somewhere our book values. On other assets, it's clear that we're going to have our work cut out for us. There could be challenges. I think that across the board, we talked before about how appraised valuations tend to lag the market in terms of both when markets are going down and the markets are coming up. So I do think that we've expected that some of the sales prices for these assets could be below their current book values. The release prices that we have from the lenders kind of acknowledge this. And again, a shorter time -- the shorter time period we have to sell, greater that discount will probably be. So the more time that we can buy here for the market to recover will help us as much as possible. But the thing that I'll say is that we're weighing -- it's a constant weighing game that we're doing here in terms of when we want to sell these assets, what we think the value recovery for an asset might be over the next couple of years. And the pace of that valuation increased. Our properties that we think are going to increase in value the most when the market recovers are the ones we want to hold on to, to be able to get that output. And the assets that we think might be more delayed in their value recovery, it might make more sense, in some cases, to go ahead and sell those assets now and redeploy that capital into another investment where we can get a higher rate of return. So it's a case-by-case basis. It's really dynamic right now, Jovi. But I'd say that on a few of the assets, we've been encouraged by the initial conversations that we've got with brokers and participants in the market.

Maybe perhaps a bit more on this because which of the 4 Tranche 1 assets we see is most likely to sort of [indiscernible] there's time we go there, and I think with the TCW Group were beginning to roll out at the end of last year. So this is also part of the factor that try on that bracket. So would the managers be looking to fill this space before you sell it? Or what is your thinking about it by the company?

That's a great question. So there has been some transaction activity happening in downtown L.A. The distress in downtown L.A. has been pretty well publicized. A lot of owners have handed keys back to the banks. So some of the properties in downtown L.A. are actually bank-owned right now. We're beginning to see, again, some of these all-cash buyers, high-net worth buyers stepping in and really making pretty aggressive plays to buildings in downtown L.A. So we've seen that transaction activity beginning to pick up there. I think that the difference -- or one of the things that we're looking at right now is how to fill the TCW space. We've got an active negotiations with several possible tenants to fill some of that space. And really what we're looking at is what is the return we're going to get on that lease that will help us increase the sale value of a property? In some cases, there's a lag between when you sign a big lease and when you see a valuation uplift [indiscernible]. And so given the time period with which we're going to want to sell these buildings or own these buildings, will really be the determinant factors whether or not we execute those kind of leases. So Figueroa is a building that we're looking at very closely, again, given the activity that we were seeing in downtown L.A. The asset in Tempe, Arizona, the Phoenix market has been pretty active. So there are buyers in that market, and we've seen a lot of activity. So we have some relatively encouraging indicators in that market. We may be able to move forward with the transaction at some point there. So I'd say that those are the insights that we have. Washington, D.C. remains a pretty tough slog right now. The U.S. government is really not back to work. I think our Penn building still has below 10% physical occupancy. Federal workers are just not getting back to the office. And the way the GSA, sort of government service agencies, the leases that are signed by government agencies have a different dynamic to them completely. And so it's Washington D.C. and especially downtown Washington, D.C. is a really tough one right now. And so I think that, that would be -- that's going to be one of the more challenging places to [indiscernible].

Sorry. And just moving on to The Children's Place now. So when does the new lease start for them?

Pat, when does the lease start for the -- I'll have Pat answer that. The new lease start for Children's Place.

Yes, it will be effective May of this year.

All right. And they paid a $4 million fee to exercise the termination of [indiscernible]. So -- and why did they terminate the original lease and signed a new one? Was it just the downsizing? Or was it [indiscernible]?

Jovi, that's a great question. I can't recall a time where I've ever seen that approach to lease negotiation or renewal negotiation. They did give us that termination fee. They said that they were leaving the building and then reapproached us as if they were a new tenant. And I think that, obviously, there are things that new tenant gets in terms of TIs and things that renewal might not get. I don't know the math on Children's Place and how they determine the payment of $4 million upfront and then getting paid perhaps a larger TI package on a new lease, how that economics works for them. But we're glad to have them back in the building. We're glad to have $4 million of cash, and they're in that building now until 2037.

And how much was the rent of the new lease? And what was the TI package you have to give them?

Pat, do you have the numbers on the rental reversion or the total TI?

Yes. I think the rental reversion was modestly -- I think it was a low single digit, maybe minus 2% in terms of reversion relative to what they were paying. But that's also a little bit of a misleading number because they were in the building for a long time. And the way gross leases work is they have escalations in their historical leases that grows the market rent. So we think we're getting a full market deal on this new lease despite a modestly negative reversion. And in the TI package, we only had to offer them about $60 in TI. And I think for this length of lease and this size of tenant, I think that's a very strong outcome. And we've certainly seen very high TI packages around the country and in our portfolio. And this feels like a relatively modest outlay for us on this tenant, especially considering it's a 12-year term. We probably would have ended there on a renewal anyway. So again, it begs the question. We're unsure why the $4 million termination payment came because I don't think we're any worse off in terms of what we may have had to negotiate if this was just a straight up renewal.

So it's $60 TI, what does that mean?

Square foot.

Square foot.

$60 per square foot. The rent is -- I'm using round numbers here just for illustration. Basically, what you have to do in the U.S. is you have to offer a tenant improvement allowance. So you have to pay out -- you have to give the tenant $60 per square foot on their space so that they can use that to fit out their space as they see fit. And so the -- those are landlord contributions in the U.S. that you have to contribute, and it's about 2 years of rent in this instance.

Just 2 more questions here. They are related. So based on your talk so far, what do tenants prefer? Like do they prefer full occupancy or a little bit higher end -- I mean cheaper rent? And also, which of your other tenants are likely to do some [indiscernible]? You already said that it's anomaly but [indiscernible].

Yes. So do you mean like what the tenants are referring in terms of...

The new tenants. Prospective tenants.

Yes. Okay.

Yes. So the second question is based on what you've seen with The Children's Place, do you think any of your current tenants are likely to do some [indiscernible]?

Yes. Again, I've never seen anybody do what The Children's Place did. So I wouldn't expect that to be a norm going forward either. I'd be surprised if we see that again. I would welcome it. So we could certainly use cash upfront. That would be great. But I don't think that, that probably -- we'll probably see that anymore. I don't think we've seen that before. But I think the tenants in the market, again, there's a definite move to quality. Those tenants are looking for the highest-quality space as possible in the best locations, and I don't think that's going to change. We've seen already on the docket or Peachtree property in Atlanta, the improvements that we're going to be started on there that have already had a very good traction in the market. Peachtree is really in the center of the location in the midtown market. And that's the kind of properties that I think that we really are attracting tenants as we move forward.

I have one question, sir.

Maybe, we let...

Kenny from REITsavvy. So Tripp, you were surprised by the drop in valuation 1 or 2 years ago. That was the first surprise to the whole market itself. And it also seems like we have a second surprise 1 or 2 weeks ago whereby before the [ capital capacity ] are supposed to release earnings, but 1 day -- or 1 or 2 days before they actually -- they had reported, there's a drop in the valuation. And suddenly, there's an announcement they have delayed the earnings release. It seems that it's maybe event related. I do not know. Do you think that there will be the third surprise for the U.S. commercial office moving forward? Just give us some color or insight.

Yes. So Kenny, that's a fantastic question. We've been telegraphing for some time that we saw additional downward pressure on U.S. office valuations. So I think that we were not surprised, especially at our year-end this year. And I think that we've continued to telegraph very clearly that the factors that went into those valuations, we continue to see those pressures here. I do think that we've seen declines or increases in discount rates and cap rates beginning to moderate. So a lot of things that go into those valuations appear to be kind of plateauing. And I think that when we look at interest rates again and the delta between cap rates and interest rates, right, when we were in a low interest rate environment, the spread between cap rates and interest rates was relatively low. So not only did we have an increase in interest rates. We also had an increase in that spread, which brought those cap rates up. Even as we see interest rates moderate, I'm not sure we see the spread from moderating from there. So I do think that, that indicates that cap rates may not lower at the same rate that interest rates lower, right? So that's the first thing that goes into valuation. So are there going to be surprises there? I don't think so. I think we understand that pretty well. I think the surprises, if they're anywhere, come up on an individual property by property when you look at what leasing you have to do with the property and what the cost of that leasing is going to be. And both when we talk about TIs, are there going to continue to be inflationary increases on construction costs and the things that raise those TIs because it's going to continue to be a tenants market because I think what we're seeing across the board in the U.S. is that the tenants generally are needing less space. So even the ones that come back and renew are often downsizing their spaces. So the leases that you're going to have to sign on a per square foot basis and the TIs that you're going to have to give to people for a lot of the new tenants who're going to have to have to rebuild that space, you're going to have these TIs. That's going to be a significant part of your budget going forward. So I do think that, that plays into valuations, and that can continue some of the downward direction on the valuations. In addition to this higher underwriting assumptions behind vacancy, I think that everybody -- all the appraisers now are putting in higher assumptions for vacancy across the board for office. So I think that you can kind of see these things. So it's hard to say where the surprises are going to come from. I think, though, that we've hopefully taken most of the pain in our valuations and our portfolio. It certainly feels like we're taking the punches ahead of some of our peers. But I don't see any other things in the horizon that -- black swan events or things that could be for surprises to the downside.

Do you think the value has already put in the worst-case scenario for the U.S. office space in terms of the occupancy rate, in terms of the cap rate?

Yes. I'll give you my view. And then Marc and Pat, I'll let you guys -- these guys are also very experienced real estate professionals. I think, again, that a lot of the worst-case scenarios have already been priced in terms of discount rates, cap rates, assumptions. Several of our properties had large -- like The Children's Place. Unfortunately, for the Plaza valuation, the valuer had to assume that The Children's Place was leaving that building. And move that vacancy and that lease-up cost was taken into account on that building. We're certain on some of our assets, the appraisers kind of take the very bottom, the worst-case scenario on which to value those assets. I think, again, across the board, it's hard -- I can't talk about this portfolio. I don't know the details about the portfolios. But it feels to me like we're near the bottom in terms of these valuations and assumptions that are being made.

Okay. My last question, probably for Robert. Based on the current U.S. interest rate futures, expected to be 150 bps drop back end of this year interest cut. So how fast can Manulife really able to take on this opportunity if really there is a 150 bps cut in order to reduce our financing costs?

Yes. We reported that the portfolio is around 69% hedged. With the sale of Park Place now, the variable part, it show -- it popped up to 91%. So we still maintain most of our swap in place that is effectively basically [indiscernible] further rises, right? So with more sales as part of this recap plan, I guess all of the loans will be paid down. And if we maintain the current hedges, which is generally much lower than what is the so far or even the long-term rates, it has the effect of further reducing the interest cost. Later part, I think, naturally, depending on how we pivot the portfolio, we'll see. We could maybe opt to let the swap naturally expire, terminate some of them to take advantage of the bill rates. So now there's nothing we need to do about the swap. We are focused on selling assets to bring down the debt. Then we do the debt capital management a bit later on.

[indiscernible] from [ Business Times ]. So I just want to follow up on the previous question. So currently, FY '23, the average interest rate is 4.15%. The sponsors are [indiscernible] 4.55%, correct? How about [indiscernible] projection? Is it going to decrease [indiscernible]? So how much do you see [indiscernible]?

4.55% for this year. Now we talk about expectations of rate cuts. Assuming we still maintain a 91% hedge, 10% will be able to enjoy the rate cuts in the second half of this year. So that's the amount. But I can't really tell you where the hedge position is going to be because there's a lot of capital transactions that we're looking at. We're looking at selling assets. We're paying down debt -- paying down debt, and we may even retire some of the swaps. It's a difficult question, but I hope to keep it around this level if possible.

The other question is on swap level. You see -- you spoke about momentum decreasing. Do you expect occupancy to start improving this year or just some of the replacement for the leases that are going to expire? Because I know gross revenue and NPI are up this half, but a lot of it is the termination fee. So it doesn't really -- it looks like it might come down next half and then on your interest [indiscernible].

Yes. [ Raj ], I think the dynamic there again is that tenants, even if we get more tenants and more renewals, a lot of tenants are downsizing. Tenants that are coming in need less space. So I do think that in order to maintain occupancy and increase occupancy, we're going to have to sign even more. In other words, I think that the momentum of that signing of leases needs to pick up even more. I think then we could see -- let's say that we were able to -- when you look at the square footage totals, what we've leased, it's really the square footage that you're looking at. So as long as we can maintain that kind of pace in terms of the square footage leasing, we'll be able to maintain that occupancy. What I will say, though, is that the number of leases being signed has to increase since the overall average of the amount of space that you're signing is probably going to be lower. That makes sense to you? You'll need to sign more leases to fill the same amount of space.

Correct. So what you say about the leases [indiscernible] strong. I mean is the trajectory towards [indiscernible]. I mean I know you can't predict all the way, but can you -- just to kind of qualify if the initiatives are strong.

Yes. We would certainly hope to hold occupancy with the kind of leasing momentum we have now. The other piece of this is that roughly 76% of the leases we did in 2023 were renewals. Obviously, those help to maintain occupancy, but it takes some new leases in order to increase your occupancy, right? So I think the more we can focus on new leases, getting new tenants in the buildings, and it's really just going to be dependent upon how much space those tenants need. So it's hard to indicate [indiscernible].

[indiscernible] positive or...

Pat, do we know the rental reversion for the leases signed in that first quarter?

I don't know off the top of my head. I'd have to dig up what the first quarter reversion was. I think it's modestly negative, to be candid.

1Q, right? You're talking about 1Q, right?

Yes.

So I think if you look at this slide -- sorry. If you look at Slide 12, right, I think the 2 major leases that we have signed in 1Q are Hyundai and Children's Place. Actually, Hyundai took over a space that kind of has been in the building for quite long and everything. So for those of you that has been following us since IPO, Michelson is one of the buildings that we bought at IPO. And some of the rents there are kind of above market. So what we have done for Hyundai, even though it's a negative reversion, but we have market to market and is still above the current passing of Michelson. So I think that's important that we actually get to market to market. Children's Place is a bit of a tricky one because I would say Children's Place is about flattish to slightly negative. I think that was explained earlier by Tripp [indiscernible] because all our leases are like the Singapore leases. When a Singapore leases talk about rental reversion, it's like the last 3 years, then you say that positive rental reversion is based on last 3 years or last 5 years. But when we say positive rental reversion for our portfolio, every year, it actually has incremental. So in the last 5 years, rent has really gone up by 2%. At the end of the 5 years, actually, rents have really increased by 10-plus, plus percent. And when we look at rental reversion, it's then the year 6 rental versus year 5. So even in the last 5 years, it's really been a positive, but in the last 6 years itself, it's slightly negative. But overall, it feels positive. So the calculation in Singapore versus in U.S. leases are a bit different, a bit of nuances. So I hope that just gives a bit color on -- I think we'll have a bit more color, I think, when we report the 1Q. We should have a couple more leases signed as we go through 1Q. Yes.

Go ahead.

Weilun from Wall Street Journal. Just curious, I mean, on the point about leasing momentum. Are you able to give a bit more color as to which sees -- which are like -- which tranches, like 1, 2, 3, have you been mostly focused on? I think it was mentioned that like in D.C., there's a bit of problem getting government workers to come back. So who are these prospective tenants and which cities [indiscernible].

Yes. I'd say that the cities where we're seeing some of the positive momentum, Atlanta is still a strong market for us. We're also seeing some momentum in Northern New Jersey at our Plaza asset and in our Exchange asset. Obviously, with The Children's Place renewing, that is a good sign for our building as well. We've had other tenants that we've been working with that building as well. Again, I think that the momentum that we're seeing really, though, across the board in most of our markets, D.C., obviously, the example of the government tenants is -- as a one-off. But in most of our markets, what we are beginning to see is that tenants who really didn't have an understanding about how much space that they're going to need moving forward are beginning to get visibility into that now. So that's really what's driving a lot of this activity in the markets, is that as these companies get an idea of what their space needs are going forward, they're out shopping for space. So it's not particularly in one specific market, but Atlanta is one of the stronger ones that we've seen.

And the general trend is at the outlook is downsize, that's why you would have had to sign all these leases?

Correct. In order to fill the same amount of square feet, we're going to have to sign more leases, which we have in the past. Yes.

[indiscernible] I've got 3 questions, but maybe I'll ask it [indiscernible], one about net income and one about divestment. So the part about net income, so I understand that you have divested 2 properties this year. So can you tell how much would the NPI be the downward factor with it? And the second question about [ PPI ] is that for Tranche 1, how much do they contribute to the current year?

Robert?

Yes. You're referring to Tanasbourne and Park Place. The thing is there is a counterbalance when you sell the assets, especially for Park Place [indiscernible]. The bulk of it is used to pay down debt. The property [indiscernible]. Park Place is about 5-ish year on the $98 million. So we used the proceed to pay the cost of debt at 7%. So it actually is a net-net positive for that transaction. Tanasbourne is relatively small asset, $30-odd million. We actually utilizes that cash for CapEx spending in the last year. So it's not just a straightforward stopping of the NPI, but what we use the cash for. So Park Place actually is a positive from an earnings perspective because of the trade-off. You lose 5% yield, you gain 7% from the cost of debt savings.

So what will be the exact [indiscernible]?

Let me just see on the 2 assets.

If you actually go to Slide 15, just go back down a little. You've got the values to the far left, right? And you have what you'd call direct cap rates. Just like for example, Tranche 1, it's roughly about $375 million [indiscernible] of the current value. And that's roughly just put out, call it an average, it looks like about 7.5% cap rate. Multiply that, you get around $25 million, $26 million. Probably just lose it because it's all unsecured debt, $375 million times 60%, which is the debt because LTV. Robert just said it's on average out of the [ swaps ] about 4.11, around that 4.15. That's about $9 million difference. So you'd probably get to like $15 million on Tranche 1. Meaning of NOI associated with that. Now you could take the 2 assets that I think Tripp was implying. I don't know if he said it directly, but you did reference Diablo and Plaza. You just assume those are the 2. That's about $100 million worth of assets at essentially 7 cap. So $7 million of NOI, $60 million of debt on average because it's all secured, so you had the same math. And again, 4%. So you got 2.4 minus 7, you get right around the $4.5 million of NPI, not just based on interest and NOI, not accounting for [indiscernible].

Those are [ this year's ] NPI?

Yes. So when you think about like when we constantly see inflation recovery and growth, what's the difference between -- among all 3. So say what's like -- we got to find that trough and values, right, so to speak, and we do that through repositioning, through active leasing and being judicious as to where to spend that capital and recycle that capital. What does recovery mean? You sort of touched upon it in the sense that with existing assets, existing portfolio, we have net property income. That's clearly declining because of where we are in the capital markets and operating cycle, but it's also declining because we're selling assets, right, [indiscernible]. So how do we recover NPI in the United States with existing portfolios? So that's what we mean by recovery. You can find out how we're doing that. Then the growth aspect is new acquisitions. But ultimately to really grow NPI and enhance value for existing unitholders is we have to take advantage of the vintage opportunities in 2024 and '25 and '26 for there to be some of the best vintage opportunities that we've seen in real estate markets in the United States in a very, very long time. I thought it was the GFC. Quite frankly, this may be even better than the GFC in terms of the opportunities today. So what are we doing about it? Like I think some of the questions that you all have asked is, look, this is going to be very challenging. There is no perfect one solution. This will require creativity to sort of solve the complex problem that we have, which is to pay down debt while stabilizing cash flow, not increasing cash flow. And on top of that, to try to balance what we call essentially a lag between what we call appraisal discovery and true spot price discovery. Right now, there's still a very big difference in where spot -- or where, call it, properties, particularly U.S. office can trade at if you sell it versus what we call appraisal. But what's happening right now and what we caught in the last 1.5 years or 2 is we saw the appraisal market being substantially higher than what the spot market is. What's going to happen at some inflection point, which we expect by midyear to maybe late 2024, appraisals are going to start to hold, but then you're going to start to see spot value start to actually increase to catch up to appraisals. And that's actually what we see from the trough, at the bottom of the cycle to the top of the cycle depending on where we're at. So we need to take advantage of that, which is we cannot forget as much as I think everyone wants us to come on for the next step, which is we effected the restructure and the recap at year-end. But really, what we bought through that is time, right? So we have to take advantage of what objectives that we deliberately set and essentially effected, which was time, right? So there's actually not any real gun to our head right now to actually go sell today. As much as we want to, to improve execution, we can't do it just to prove it. Like we have to take advantage of what we did deliberately through the restructuring and the recap, which is to buy time. And to buy time to do what? As Tripp was talking about, it was to essentially sell assets as close as possible to appraisal value, not just sell assets at essentially where we can trade because it's liquid at that price if it's significantly below current appraisal value, right? Sometimes, as Tripp noted, it's going to make sense because we don't see anything to improve even off spot values today. Forget -- even if appraisal values keeps on going down, right? So if that's the point, then we would sell. But right now, we're not making that call because there's clearly green shoots, to your point or question, in what we call the operating market for office. You saw in December for the first time sublet activity actually pull to decline in most markets. You also saw leasing activity in December compared to November start to pick up in general. And what you're seeing now is the beginning, what we call a normal functioning operating market for office where the spreads between Class A product and, call it, non-Class A product, Class B or Class C, are so wide and large. So for example, downtown L.A. versus West L.A. and monthly rents, $8 per foot in West L.A. versus $4 per foot in downtown L.A. 100% differential. So what that means is now tenants actually have to decide, do they want to pay 100% more or do they want to move to downtown L.A. and get a cheaper rent? The differentials weren't so large, meaning that they weren't large enough to where people really had to think about it. They were just thinking about downsizing moving into Class A product, having a smaller footprint, but all in dollars, pay the same or less. But that's no longer a question because all the positive net absorption in office has been in Class A product, right? So keep driving it up and up and up. And if you look at some of the best office markets or micro markets in the country, there's actually been rent growth. Now we can debate net effect of rent growth or not because TI package is at the march. But at the end of the day, there's now a real debate like around these other markets like downtown L.A. or even parts of Washington, D.C. The interesting part again about what we need to do in terms of executing is we're one of the few landlords now that has liquidity to capitalize leases. In certain submarkets, you actually have bank-owned properties who are not going to capitalize leases. So it's actually an opportunity when we call the leasing markets to go out there and win with less competition, right? So when you look at downtown L.A., bank-owned and other landlords are just not entertaining any [indiscernible]. So what do we do about it? We can't make crazy deals like negative NER deals, right? But the question is, how do we take advantage when there's less competition, right? And then we'll leave you with this. It looks like maybe not so accretive today because of where cap rates are today. As we like to say, if you're just taking that asset value for a company the way we do in United States, which is the NOI of a public company like SL Green [ running the mills ], divide it by the cap rate, you get your enterprise value, [ and that's your debt ]. That's your through net asset value, not based on appraisal value or book value from an accounting perspective. Who's to say today value's picking a number? I'm not saying this is where it's at. The NAV at a 10 count today is right versus 3 to 5 years of rates drop and what we see continued recovery in the office market. And it's at an 8 cap. Everything else the same. Which value is correct? Today at 10 or 3 to 5 years from now, if it's an 8 cap. But everything else is the same. It's just the way cyclical markets work. So we have to keep that in mind. We'll keep on reminding ourselves this because of what we did at year-end is we manage it as a going concern, including for unitholders. So the balance of what we need to do in the short term, which is to continue to pay down debt, right, which is what we need for the lenders and unitholders, but also keep our eye on the price, which is a longer-term recovery in unit value, right? And so for those properties we think are long-term strategic versus non, that's where we need to actually commit. So there's always a lag, by the way, always a lag in the U.S. property market. So when you brought up the question on occupancy, it's really not leased. So occupancy can keep on dropping while the lease percentage can actually start to increase. We want to actually start to see occupancy pick up until 1 or 2 years later when we act -- when the tenants actually -- when we deliver the space and then begin to occupy the space. So something like post GFC as a rule of thumb, when did delinquencies and the values pick up? Not during the GFC. The peak was in 2012, about 2 years after the GFC, right? So we don't want anyone -- like we just call this noise. It looks like all these metrics might be getting parsed, but what people are missing are the real green shoots of actually where it's actually beginning to improve. It may not show up today, including NPI. But if you go and execute that lease after the burn off of free rent in 1 or 2 years, you're going to start to see NPI. Now the hard exercise and challenge is this. We still have all these optimization factors. We got to sell properties to pay down debt, right, which can also be constrained on everything else we're trying to do, including the limit of the capital that we do have to spend on the right types of leases. It's hard, but we believe we can do it, right? But all of these factors are what we -- variables are what we keep in mind. But we just don't want anyone else to get hooked on certain metrics and think things are actually getting worse when, in fact, they might be getting better. But simply put is we got multiple objectives, pay down debt, meet the lender covenants on top of that, grow, recovered existing NPI on existing properties to figure out how we really ramp it up with growth opportunities through acquisitions for the right type of properties at the right vintage spaces.

Can I just follow on that point? You talked about growth and you want to pay down the debt. I mean to grow and acquire a property, you need more capital as well. But how is it going to work out given the sponsors are a little bit -- how are you going to raise equity to market with the 8% cap going forward? I mean it will still be harder to capture -- you say the best opportunities even compared to GFC. So how are you going to capture on that?

Well, we have to do what we need to do in the near term, which is execute first around particularly the key objectives and requirements around restructuring and recapitalization plan for the master restructuring agreement. We have to prove some execution first in the near term. So when Tripp references -- we referenced the sale of 2 assets, I call it 2Q, 3Q this year, roughly about $100 million, maybe more, we got to prove it to earn the trust of the market, again, public markets. We start to execute, and we start to pay down debt. We do a lot of the little things that Robert was referring to in terms of what we call manage the cash flow around interest rates and without an increasing interest rate risk but to take advantage of swaps of a value, right? So we're confident around when we're going to sell. Maybe we lead a little bit and we retire those swaps, which brings in cash. So all those little things add up, every $1 million or even $0.5 million. But once we start to show that we're executing, including executing around major leases at some of our bigger assets, what we would expect is some level or recovery in stock or unit price, right? And what happens is when you're a public company, you do need a recovery in price. We do get that because it's still capital markets. We would hope to raise equity at the right -- for the right opportunity. Are we going to do it at $0.05 or $0.06? No is the answer, right? But again, for the right opportunity to acquire or it can prove it's accretive, the acquisition, might be short-term dilutive to the shareholder base or unitholder base, but it's not going to be 100% dilutive, right? But also at the same time, what you really are implying to your question is we get the right balance on new transactions, let's call it, 30% debt, 70% equity, the right size. What does it do? It delevers, right? It delevers while still [indiscernible] NPI of the new acquisition. And what's the utility value of delevering right now? You're actually derisking. There is tremendous amount of utility value. You actually take that even further, you derisk, discount right on the entire company, right? It probably goes down, which increases the value implicitly of the company, right? So that's sort of the thought process, but...

[indiscernible], yes, absolutely. You cannot really [indiscernible]. I was just wondering more from the perspective -- I mean I get it when the prices are [indiscernible], but would there be still a hurdle because what some unitholders do not want to subscribe?

Maybe I can just give more color to your question. I think that's been actually asked by all unitholders. I mean even this year, end of last year, we have unitholders asking why not raise equity sooner rather than later. So just to give some color on how we look at -- we need to normalize at some point, really below 45%, get distributions back. This said, we have a lot of questions online from the retail investors or so. I mean the key priority is to get distributions back ASAP, sooner rather than later if we can. And the first thing that we have to do is look at our disposition, which is why -- when they're able to sell the asset, kind of like they're selling it, what's the gearing going to be, whether we have a meaningful amount. I mean when that happens, like what Marc said, the share price should start to recover slightly or hugely, preferably. And at the right time, I mean, like when we are able to execute, we are able to show the market that we are set to deliver, hopefully, we get better confidence on investors. And if the share price recovers to a point that equity fundraising is no longer that big an amount because our market cap now is 110-ish, right? To do any equity fundraising at this price is not possible just because it's going to be massive. It's going to be a one-for-one. And your point is who's going to underwrite it? That's the million-dollar question. So the same thing for how the banks and lenders and all the stakeholders look at it is for them to be confident of what we are doing, re-rate and to get back to norm. We need to show that there's growth. We are doing the right thing, but in the right market. We got the right assets. And then together, we can bring back these underwriters. And hopefully, the amount wouldn't be as big as that will be too scary. The first instance that the market will have to take. So that is how I think we look at the equity fundraising thinking. It's definitely something that we are thinking of very closely. And we also have investors who come to us and say, a few of us can come and give you $100. But then my question is, does it bring it back 40%, right? And at this point, I think if we can, the thing is any big equity fundraising in this space should bring us back to 40 or so immediately. It shouldn't be like I think you covered [indiscernible] price issue and then I get there because then there's nothing for unitholders to look forward to in terms of distribution. So that's our high-level thinking. And hopefully, as we execute our recap plan, market maybe is looking better, and I don't know that's how many fed rate cut, depending on who you are talking to. They will have to stabilize [indiscernible] economy. I think we may have like 5 more minutes.

Like raising equity, about $30 billion to $40 billion is very, very different from raising $200 million. That $200 million is extremely dilutive. That's the big risk. But for the right acquisition and raising equity at $30 million, doing it incrementally, that's really being judicious at the end of the day. And tie it to the right growth opportunity, I think that can be sold to the market that we can show to unitholders, whether they're new or whether they're existing, that is the right opportunity at the right price, and most importantly, that there's long-term values for the existing portfolio and what we're doing in terms of the overall pivot strategy. Again, they're not an all-or-none one solution. So this is why -- this is what we get paid to do, is to execute around everything in a very challenging environment.

Okay. I'm sorry. Because we are out of -- we've got quite a full day of meetings today. So unfortunately, I have to stop right now here. There are a lot of questions online, but give us a bit of time, and we'll get back to you with the answers. So I think on behalf of management and our Chairman, we just want to thank you for joining us here as well as the online. For those who are celebrating Chinese New Year, I wish everyone a Happy New Year. [Foreign Language], right? So thank you very much. Goodbye.

Thank you, everyone, online and...

Thanks. Thanks a lot.