Latest / Investor Exchange / Keppel Pacific Oak US REIT 1H 2025 Financial Highlights and Market Outlook

Transcript

Keppel Pacific Oak US REIT 1H 2025 Financial Highlights and Market Outlook · Investor Exchange

• 0:02
  Time for another Investor Exchange podcast. Here are your hosts, Matt and Sally.
• 0:07
  Welcome to The Deep Dive. We're the show that helps you cut through the noise
• 0:11
  of those dense reports and complex financial statements. Exactly.
• 0:15
  We try to find what really matters.
• 0:17
  And today we're doing just that. We're plunging deep into Keppel,
• 0:20
  Pacific, Oak, U.S. REIT, or COREY.
• 0:24
  Specifically, their unaudited results for the first half of 2025.
• 0:28
  So the period ending June 30th. Yeah. And it's an important one to watch.
• 0:32
  Cori, well, they're not just any REIT. They focus on U.S. offices,
• 0:36
  specifically in what they call key growth markets. Right. Not just anywhere.
• 0:40
  Not just anywhere. I think fast-growing sectors, tech, advertising,
• 0:44
  media, the Tame of My Group, but also medical and healthcare.
• 0:47
  It's a diversified portfolio.
• 0:49
  So as of June 30th, what did that portfolio look like? Okay.
• 0:53
  So they had 13 freehold office buildings and business campuses.
• 0:56
  The valuation was roughly U.S. $1.3 billion, spread across eight of those key
• 1:01
  growth markets. Got it. So that's our focus.
• 1:03
  Our mission, really, is to unpack Corey's financial performance for this first
• 1:07
  half. Figure out the why behind the numbers.
• 1:09
  Exactly. And then we need to look at the broader market outlook,
• 1:12
  you know, see what it all means for Karat's future.
• 1:15
  And we're pulling this straight from their recent media release and presentation.
• 1:18
  So getting it directly from the source. Perfect. OK, so let's jump right in.
• 1:22
  The overall financial snapshot for 1H 2025, what immediately jumps out at you?
• 1:28
  Well, let's lay out the headline figures first.
• 1:30
  Gross revenue, it saw a tiny increase, just 0.2% year-on-year,
• 1:35
  up to U.S. $74.6 million.
• 1:38
  Okay. Pretty flat then. Pretty flat. But then, net property income,
• 1:41
  MPI, that decreased by 3.2%, landing at U.S. $40.7 million.
• 1:46
  Mm. Okay. A drop there. And if you look at adjusted MPI, which kind of gives
• 1:50
  you a better sense of the cash property income, it was down a bit more, 4.6%, to U.S.
• 1:55
  $41.4 million. So revenue basically flat, but property income,
• 1:59
  both reported and adjusted, is slipping.
• 2:01
  What about distributions? That's usually key for REIT investors.
• 2:03
  Ah, yes. That's probably the biggest headline here. Income available for distribution,
• 2:07
  well, it took a noticeable hit.
• 2:09
  Down 16.2% to U.S. $19.9 million. 16%, okay. And net income for the period fell even more sharply.
• 2:17
  Down 42.5% to U.S. $11.7 million.
• 2:21
  Wow, quite a drop. But here's the crucial part, and it ties into their strategy.
• 2:27
  No distribution was declared for the first half of 2025.
• 2:30
  Right. And this wasn't exactly a shock, was it? This was flagged before. Correct.
• 2:34
  It's part of a recapitalization plan they announced way back on February 15th, 2024.
• 2:39
  So it's playing out as planned, essentially. Okay. So remind us,
• 2:42
  what's the main purpose behind suspending these distributions?
• 2:45
  It runs for quite a while, right? It does.
• 2:47
  They suspended them starting from the second half of 2023.
• 2:50
  And it's planned to go right through to the second half 2025 distribution.
• 2:54
  That's the one that would normally be paid out in early 2026.
• 2:57
  And the goal? The stated goal is pretty clear.
• 2:59
  Address their capital needs and leverage concerns.
• 3:03
  Basically, hold on to cash. Makes sense in the current climate. Yeah.
• 3:07
  I mean, given the challenges in the U.S. real estate market,
• 3:09
  selling properties at good prices is tough and raising significant equity is,
• 3:13
  well, unlikely for many REITs right now. So this suspension is a deliberate move.
• 3:17
  Fortify the balance sheet. But they did leave the door open slightly for resuming earlier.
• 3:23
  They did. They mentioned distributions could start again sooner if market conditions
• 3:26
  really improve significantly. But, you know, that's a big if.
• 3:30
  OK, that sets the stage. It's about long term stability.
• 3:33
  But let's dig into the why. Why did those MPI numbers drop? What were the main drivers?
• 3:39
  The sources point to a few things. The main pressure on MPI came from increased
• 3:43
  repair and maintenance costs.
• 3:45
  Those jumped 13.2% year on year. That's quite a bit. Definitely.
• 3:50
  Anything else. Yeah. Also higher amortization of leasing commissions.
• 3:52
  It's basically spreading out the cost of getting tenants signed up.
• 3:56
  And, you know, general property management fees and other property expenses
• 3:59
  also ticked up. So rising operational costs are a big part of the story.
• 4:03
  Were there any counterweights, anything pushing the other way?
• 4:06
  There was one significant offset, lower property taxes.
• 4:10
  They were down 12.5%, which helped cushion the blow a bit. But then,
• 4:14
  looking at that adjusted NPI figure, the one that focuses more on cash,
• 4:19
  A key factor there was lower cash rental income. And that was because of what
• 4:23
  they called higher free rents.
• 4:25
  The rent-free periods for new tenants.
• 4:27
  Exactly. It's about the timing differences when new leases start.
• 4:31
  You often give a few months free rent as an incentive.
• 4:34
  So while you secure the tenant long term, the immediate cash coming in takes a temporary dip.
• 4:40
  That's interesting. It suggests maybe a pretty competitive leasing market out
• 4:44
  there offering those incentives.
• 4:45
  It certainly points that way. It's a common tactic, you know,
• 4:47
  to attract or keep tenants in tougher markets.
• 4:51
  OK, now moving to that bigger 16.2 percent drop in income available for distribution.
• 4:56
  Yeah. What drove that? Well, part of it was the lower cash NPI we just talked
• 5:00
  about. But another big piece was significantly higher other trust expenses.
• 5:04
  They jumped 34.1 percent. That's about U.S.
• 5:07
  Sort of 0.6 million dollars. And what falls under other trust expenses?
• 5:11
  Primarily increased professional fees. But also, this interesting item.
• 5:16
  Accrued withholding tax.
• 5:17
  Withholding tax. How does that work for a REIT? Yeah, it's quite specific.
• 5:20
  It seems this accrued tax happened because a chunk of their unit holders didn't
• 5:25
  submit the necessary valid U.S. tax forms.
• 5:28
  This is happening during the distribution suspension period.
• 5:31
  So it's an admin issue impacting the bottom line.
• 5:33
  Pretty much. KROE actually put out a call urging unit holders to get those forms
• 5:37
  in, because if they don't, it directly hits the retained income.
• 5:41
  And it could even mean clawbacks from future distributions when they restart.
• 5:46
  Wow. So, Uniholder action is directly impacting the trust's finances there.
• 5:49
  Okay. And then the big one, that 42.5% fall in net income. What happened there?
• 5:54
  A major factor there was non-cash. It was a fair value loss on derivatives.
• 5:58
  U.S. $6.5 million loss in the first half of 2025.
• 6:02
  Derivatives. So, interest rate hedges. Exactly. These are tools Carey uses to
• 6:06
  manage interest rate risk.
• 6:08
  But when market rates move, the value of these hedges on paper can swing quite wildly.
• 6:12
  So it's a big hit to reported income, but doesn't necessarily mean cash flowing
• 6:16
  out the door right now. Precisely.
• 6:18
  It reflects the volatility in interest rates, but it's a non-cash accounting item.
• 6:23
  It compared to a small gain in the same period last year, so it's a big swing factor.
• 6:28
  Also, tax expense nudged up 5.8%, mainly due to higher deferred taxes related
• 6:34
  to property depreciation.
• 6:36
  Okay, so we've covered the downward pressures, higher costs,
• 6:38
  tenant incentives hitting cash flow, some admin tax issues, and that big non-cash derivative loss.
• 6:45
  But it can't all be bad news. Were there any bright spots operationally?
• 6:49
  Any signs of resilience? Oh, absolutely.
• 6:52
  Yeah, despite those financial headwinds, operationally they showed some definite
• 6:55
  strength. Leasing Omendam was actually quite healthy. Really?
• 6:57
  How much space did they lease?
• 6:59
  They signed deals for 281,230 square feet in the first half.
• 7:03
  That represents almost 6% of their total portfolio area. And where was this activity happening?
• 7:10
  Predominantly in those key growth markets they target. Places like Seattle,
• 7:14
  Bill, V. Redmond, and Denver saw a lot of the action.
• 7:16
  That's a good sign their strategy is working on the ground. Okay,
• 7:19
  leasing volume looks decent. What about the actual rents? Are they getting higher rates on new deals?
• 7:24
  Yes, and that's another positive signal. They achieved positive rental reversion.
• 7:29
  Meaning rents on new and renewal leases were higher than the expiring ones. Correct.
• 7:33
  It was 3.3% positive for the second quarter and 0.5% positive for the first half overall.
• 7:39
  That means future income should benefit. And occupancy, did that hold up?
• 7:43
  It stayed pretty healthy.
• 7:45
  Portfolio-committed occupancy was 88.2% as of June 30th.
• 7:49
  It dipped slightly from 90% at the end of 2024, but, you know,
• 7:54
  88% is still a solid number in today's office market.
• 7:57
  Definitely. And the types of leases signed, new tenants, renewals. A good mix, actually.
• 8:02
  New leases made up about 35% of the square footage signed.
• 8:05
  Expansions were around 17%, and renewals took the largest share at about 48%.
• 8:10
  That suggests a healthy balance of attracting new business and retaining existing tenants.
• 8:15
  And they mentioned tenant diversification, right? That's usually a plus. A big plus.
• 8:19
  They really highlighted their low tenant concentration risk.
• 8:22
  Get this. Their top 10 tenants only account for about 29% of their cash rental income. That is low.
• 8:28
  Yeah, spread across over 390 distinct tenants.
• 8:31
  So if one major tenant leaves, it doesn't cripple them. Huge diversification
• 8:35
  benefit there. Plus, they have built-in rent increases.
• 8:38
  Ah, the annual escalations. Yep. An average annual rental escalation of 2.6%
• 8:43
  across the portfolio. So that provides a little bit of organic growth baked
• 8:47
  in regardless of market conditions. That's a nice safety net.
• 8:51
  Okay, let's shift gears to capital management. How are they handling their debt?
• 8:55
  What's the leverage situation?
• 8:57
  So their aggregate leverage was 43.7% at the end of June.
• 9:00
  That's pretty consistent with recent quarters. And importantly,
• 9:03
  it's within the regulatory limits.
• 9:05
  Okay, under the ceiling. What about interest coverage ratio, the ICR?
• 9:09
  That's always a focus. Their ICR stood at 2.5 times, and the all-in average
• 9:13
  cost of their debt was 4.45%. 2.5 times ICR.
• 9:18
  And managing interest rate risk in this environment must be crucial.
• 9:21
  What are they doing there?
• 9:22
  They've been quite active. About 76%, 75.7% to be precise, of their loans have
• 9:27
  been hedged using floating to fix interest rate swaps.
• 9:30
  That's designed to buffer them against rate hikes. And their debt maturity profile.
• 9:35
  Anything come and do soon. The weighted average turn to maturity is 2.0 years.
• 9:40
  Now, one point to note, their current liabilities did exceed their current assets
• 9:46
  by about U.S. $83.6 million.
• 9:49
  Okay. How are they addressing that liquidity aspect? Well, this brings us back
• 9:53
  again to the distribution suspension.
• 9:55
  The manager explicitly states that suspending distributions is key to maintaining
• 10:00
  sufficient liquidity for their obligations. Okay.
• 10:02
  And they believe it improves their refinancing prospects down the line,
• 10:06
  though, of course, they add the caveat that it's all subject to market conditions.
• 10:10
  So that suspension really is central to their whole capital strategy right now
• 10:14
  for liquidity, for leverage, for refinancing.
• 10:17
  Absolutely. It's the main lever they're pulling on the capital side to navigate this period.
• 10:20
  And like we mentioned, they're also pushing unit holders on those tax forms
• 10:24
  to help the cause. It impacts the trust's retained income directly. Right.
• 10:28
  OK, we've unpacked Karami's specific situation, but how does this all fit into the bigger picture?
• 10:34
  Let's zoom out to the U.S. economy and the office market overall. What's the vibe there?
• 10:39
  Well, economically, the U.S. picture is, you know, a bit mixed,
• 10:42
  but showing stability in some areas.
• 10:45
  Unemployment and labor force participation rates have held steady,
• 10:48
  even though Q1 GDP saw a little dip. And inflation.
• 10:52
  Still the big story. It's moderating. Holding in the 2.4 to 2.8 percent range,
• 10:58
  continuing that downward trend.
• 11:00
  The Fed is holding rates steady for now, despite, you know, quite a bit of political
• 11:04
  noise about cuts. Any word on those tariffs that were announced? Did they rattle things?
• 11:08
  According to the sources we looked at, the impact seems to have been somewhat dampened.
• 11:12
  Consumer confidence actually went up and market volatility lessened in Q2.
• 11:17
  So perhaps less disruptive than initially feared. Interesting.
• 11:20
  Okay, that's the macro backdrop.
• 11:22
  What about the U.S. office market specifically?
• 11:24
  Still doom and gloom, or are there green shoots? Definitely seeing signs of
• 11:28
  resilience, maybe even some green shoots.
• 11:30
  Office-using industries are holding up okay, and the big wave of federal lease
• 11:35
  termination seems to have passed, which helps stabilize occupancy overall.
• 11:39
  And the return-to-office push, is that actually happening?
• 11:41
  It looks like it. The data they cited, based on cell phone tracking,
• 11:45
  shows office traffic is up to nearly 73% of pre-pandemic levels.
• 11:50
  73%, that's significant. It is.
• 11:53
  And it's apparently being driven hard by sectors like finance and tech.
• 11:57
  You know, the big banks, companies like Dell, Amazon, pushing for five days
• 12:01
  a week back in the office.
• 12:02
  Okay, so people are coming back. What about leasing activity?
• 12:05
  Because Corey's numbers suggested some softness, maybe linked to incentives?
• 12:10
  Yeah, the overall market saw a slowdown in leasing in the first half of 2025.
• 12:15
  But the general view seems to be that it was maybe a temporary blip.
• 12:19
  Recovery is kind of expected in the second half of the year.
• 12:22
  And rents, concessions.
• 12:23
  Executed rents are apparently trending up, and those concession packages,
• 12:27
  like the free rent periods, seem to have stabilized after rising for years.
• 12:31
  That's a positive sign for landlords. Any movement on the sales side,
• 12:35
  are people actually buying office buildings again? Yes, and this is quite telling.
• 12:40
  Institutional investors, the big players, are starting to dip their toes back
• 12:44
  in. They apparently made up over 25% of office acquisitions in Q2.
• 12:48
  That's the highest share they've had since mid-2022.
• 12:51
  Wow. Okay, that suggests a real shift in sentiment if the big money is coming back.
• 12:56
  It could be a turning point or at least a sign that some see value at current pricing.
• 13:01
  Now, Cary focuses on these key growth markets, the Super Sun Belt 18-hour cities.
• 13:06
  How are those specific markets performing compared to, say, the national average
• 13:11
  or the big coastal gateway cities?
• 13:13
  Right, and this is central to Cary's whole thesis.
• 13:15
  These markets, like Seattle, Denver, Austin, they're generally expected to outperform.
• 13:20
  Over the last 12 months, office rental growth in Cary's key markets averaged
• 13:24
  0.3%. Okay, 0.3%. How does that stack up?
• 13:27
  Well, the U.S. national average was slightly higher at 0.6%.
• 13:30
  But interestingly, the traditional gateway cities actually saw a decrease of 0.2 percent.
• 13:35
  So Cary's markets grew, just not quite as fast as the overall average in the
• 13:39
  last year, but significantly better than the gateways which actually shrank.
• 13:43
  What about the forecast?
• 13:44
  Looking ahead 12 months, the projection for Cary's markets is 1.0 percent rank growth.
• 13:49
  U.S. average forecast is 1.3 percent, and gateway cities are forecast at 0.9 percent.
• 13:55
  So still positive growth expected in their chosen areas, slightly behind the
• 13:59
  overall U.S., but ahead of the gateways.
• 14:01
  It reinforces that defensive positioning, maybe? Seems like it.
• 14:05
  Their markets are expected to be resilient, even if maybe not the absolute fastest
• 14:09
  growing in the immediate term.
• 14:11
  Now, the sources also mentioned some specific things happening in those gateway
• 14:15
  cities, didn't they? Some political or social factors.
• 14:18
  They did, and it's worth noting, just reporting what the sources said.
• 14:21
  In California, for instance, they mentioned job losses linked to deportations
• 14:25
  and concerns about ongoing protests potentially affecting the economy there.
• 14:29
  Okay. And New York? In New York City, the recent mayoral primary election won
• 14:34
  by a socialist Democrat reportedly created some uncertainty among business owners.
• 14:39
  The sources mentioned concerns about policies, taxes, crime,
• 14:42
  anti-Semitism, and specifically noted that some firms were considering relocating
• 14:47
  to markets seen as more business-friendly, like Miami, Dallas, or Nashville.
• 14:52
  Again, that's just relaying the information provided in the materials. Understood.
• 14:55
  Purely reporting the source material. But it certainly paints a picture of different
• 15:00
  dynamics at play in different major cities, maybe reinforcing Corey's focus
• 15:03
  on its chosen growth markets. So wrapping this all up, what's the manager's
• 15:08
  stated strategy going forward?
• 15:10
  It's pretty consistent. They're focused on enhancing operating performance.
• 15:15
  So leasing, managing costs, and that strategic capital management we discussed,
• 15:20
  especially the distribution suspension, the goal is sustainable long-term value.
• 15:24
  And they still believe in their market focus.
• 15:26
  Very much so. They highlight their presence in those fast-growing states and
• 15:29
  the focus on resilient sectors like TEMA and medical health care as key strengths.
• 15:33
  Plus, that tenant diversification provides a strong buffer. Okay.
• 15:37
  So this deep dive into Corey's first half of 2025.
• 15:41
  It's been really revealing. We've seen them navigating a, well,
• 15:45
  a pretty complex financial path. Definitely.
• 15:48
  Marked by that deliberate distribution suspension to shore up the balance sheet. Right.
• 15:52
  But alongside that, some healthy operational science, good leasing momentum.
• 15:56
  Positive rental reversion. They're managing debt carefully, and they're sticking
• 16:01
  to their strategy of being in specific U.S. growth markets.
• 16:04
  It really feels like a period of deliberate adjustment, weathering the storm
• 16:09
  now to be better positioned later.
• 16:11
  So here's something to think about as we finish. The broader U.S.
• 16:15
  Office market is showing these tentative signs of recovery, maybe starting in
• 16:19
  the second half of this year. At the same time, some of those big traditional
• 16:23
  gateway cities are facing, well, unique headwinds, political, economic.
• 16:29
  So what does this potential shift mean for REITs like CORE, the ones who deliberately
• 16:33
  chose not to be in those gateways, but instead bet on these emerging growth markets?
• 16:38
  Could we see a real shift in the balance of power or maybe opportunity in U.S.
• 16:43
  Commercial real estate in the next few years? That's the big question,
• 16:46
  isn't it? How this divergence plays out.
• 16:50
  Music.