Keppel Pacific Oak US REIT (KORE)’s manager announced their plan to suspend the REIT’s distribution until 2HFY2025. Ouch! Consequently, KORE’s unit price plunged by ~40%.
In light of this event, it is worthwhile to analyze what happened and try to learn valuable lessons for our investing journey.
What Happened?
Based on its latest financial updates, KORE’s manager plans to suspend the distribution payout until the end of 2025. As of FY2023, KORE’s aggregate leverage ratio stood at 43.2%. The current ratio is still far from the regulatory limit of 50%. So, what drove them to suspend the distribution?
US Commercial Real Estate Crisis
The first one is the state of the US commercial real estate. We previously covered the possible impending US commercial real estate crisis, and this seems to be playing out at the moment. KORE’s portfolio faced a 6.8% decline and might experience additional impact in the months or years ahead, as the US commercial real estate is projected to undergo a valuation adjustment. A further devaluation of its portfolio value may cause more pressure on its aggregate leverage ratio and potentially cause it to exceed the regulatory limit.
High Leverage and Loan Availability
With the US commercial real estate showing a weakening trend, lenders have also become very cautious with the real estate market. While the maximum aggregate leverage ratio set by the MAS is 50%, banks are already reluctant even when the ratio exceeds 45%. This is likely due to the higher lending risk accounting for the possibility of a deeper correction in the real estate valuation.
Because KORE’s aggregate leverage ratio stood at 43.2%, it is already very close to the ‘acceptable’ level most lenders are comfortable with. Given the potential for further correction in its portfolio value, it can be more challenging for KORE to secure loans with competitive rates in the short term. Even if KORE can tap more loans to fund its operation in the next two years, its aggregate leverage ratio will likely climb to an undesirable level.
Proactive Measure
KORE’s manager has considered various options, such as divestments, fundraising, distribution reinvestment plan, and sponsor support, but ended up with distribution suspension as the most viable option.
With a distributable income of US$52 million in FY2023, the REIT’s strategy of withholding distributions for the second half of 2023, FY2024, and FY2025 is expected to conserve approximately US$130 million. The manager anticipates withholding distributions will adequately meet 2024 and 2025 capital requirements, eliminating the need for further contributions from unitholders. This will also lower its aggregate leverage ratio to approximately 32%, which is a much healthier level.
Unfortunately, the path of distribution suspension is undesirable news because most unitholders are likely in this REIT for its distribution.
On the positive side, KORE’s manager’s proactive approach in suspending distributions signifies their commitment to strengthening the REIT’s financial position. This move aims to address anticipated challenges and ensure the REIT’s long-term success.
What Can We Learn?
Dividend Is Not Guaranteed, Fundamentals Matter
Many dividend investors like to see dividend yield as one of the most important factors when deciding where to invest. The high dividend yield is excellent, but ensuring the dividend is sustainable and growing should be the more important consideration.
Ultimately, dividends can only be paid regularly if the business consistently generates positive cash flow. The fundamentals of the businesses matter more because they eventually determine the dividends distributed to investors.
Strong Sponsor?
KORE has strong sponsors: Keppel and KPA. So, why didn’t they ‘bail out’ KORE? Well, we are not in a position to answer that question, but this can be a lesson to learn: Having a strong sponsor does not automatically mean having an infinite resource to tap whenever financial difficulties arise. It is better to have a strong sponsor, as it can assist in unforeseen, challenging scenarios. But nothing is guaranteed.
Macroeconomy Matters
If you have been following the news last year, you may have seen the red flags surrounding US commercial real estate. We have raised the alarm on this issue before and have avoided REITs with significant exposure to the US commercial real estate market.
All REITs, even the weaker ones, will do well when the economy is good. When the economy is bad, all REITs, even the stronger ones, will not do well.
Given the anticipated valuation adjustments in the US commercial real estate market amidst the current rate hike cycle, it is reasonable to expect that all REITs, even the more resilient ones, will face some impact. We believe KORE is one of the stronger ones, yet it is still heavily impacted.
What Would We Do?
This development is bad news to KORE unit holders. Because most investors are in it for the distribution, it is no surprise that the price has dropped as most investors exit their positions.
Fortunately, we do not have any position in KORE, so we are not directly impacted by this distribution suspension. Despite the low valuation following the price decline, we are not in a rush to add any position to KORE. We will continue to monitor the situation in the US commercial real estate sector for signs of a potential turnaround.
Were you a unitholder of KORE? If yes, did you sell your position?
You can check our Singapore REITs page to learn more about other REITs in Singapore.
