Prosperity REIT - Negative rental reversion tapering off
- FY22 distribution income dropped 8.4% to HK$245m, slightly below our estimate due to higher-than-expected cash finance cost
- Reversionary growth on a recovery path
- C.50% of lease renewals in 2023 has been concluded, which points to firm occupancy ahead
- Maintain BUY with a DDM-based TP of HK$2.49
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Despite higher rental-related income from increased management fees and air-conditioning income, total revenue declined 2.5% to HK$434m, mainly resulting from negative rental reversions at The Metropolis Tower and Prosperity Millennia Plaza. While spot rents at The Metropolis Tower exhibited signs of stabilisation in 2H22, rental reversion for the property stayed at c.-15% with high expiring rents. On the other hand, Prosperity Place, Prosperity Centre, and Trendy Centre registered mildly positive rental growth from renewals in 2H22. Hence, rental reversion of the portfolio turned less negative, landing at -4.6% in FY22 from 1H22’s -5.9%. This resulted in the average effective unit rent falling 4.2% y-o-y to HK$22.63psf.
Leasing demand has gradually picked up since the relaxation of social distancing measures in Apr 22, especially from large-sized tenants. After the recruitment of a watch/jewellery tenant that was relocating from Tsim Sha Tsui, occupancy at The Metropolis Tower in Hung Hom improved to 95.7% in Dec 22 from Jun 22’s 91.5%. Occupancy at Trendy Centre also picked up to 98.3% in Dec 22 (Jun 22: 94.8%). Meanwhile, 9 Chong Yip Street saw its occupancy soften to 94.8% in Dec 22 (Jun 22: 97.6%) due to frictional vacancies. Overall, portfolio occupancy stayed firm at 96.3% as of Dec 22 (Jun 22: 96%). The retention rate during the period was high at 76.1%.
Total property expenses rose 4.5% to HK$86m. This, coupled with lower revenue, brought the cost-to-income ratio higher, to 22.1% (FY21: 20.9%). Hence, net property income fell by a larger 4% to HK$338m.
In FY23, 45.6% of portfolio leases, in terms of gross rental area, is scheduled for renewal. Of these, c.50% has been concluded, which should point to steady occupancy ahead. Given declining expiring rents, rental reversions in FY23 are expected to improve further from FY22’s -4.6%.
Enhancement work at the internal floors of The Metropolis Tower is well underway. With budgeted capex of HK$40m, the entire facelift is expected to be completed in 2024. Elsewhere, Prosperity REIT will replace one out of three chiller plants at The Metropolis Tower in 2023. This should help save utility costs amid rising electricity tariffs.
Cash finance cost rose 27% to HK$58m, mainly led by higher HIBOR. As of Dec 22, total debt stood at HK$2.34bn (Jun 22: HK$2.34bn). This translated into a gearing of 23.4%, up slightly from Jun 22’s 23.1% due to a revaluation deficit from investment properties. The capitalisation rates of the portfolio were unchanged at 3.7% to 4.3%. In 2H22, a three-year HK$938m and five-year HK$602m sustainability-linked syndicated loan with a blended interest margin of 113bps were drawn to refinance the HK$1.54bn term loan that expired in Nov 22. The HK$430m revolving facility due in Nov 22 was extended into a dual tranche consisting of a three-year HK$262m and a five-year HK$168m sustainability-linked RCF. The REIT has no refinancing needs until 2025. Due to the expiry of interest rate swaps, its hedging ratio dropped to c.55% in Dec 22 (vs. Jun 22’s 79%) and is expected to be maintained at this level throughout 2023.
Prosperity REIT is trading at 6.3-6.6% distribution yields for FY23-24. Rental declines upon renewals in the portfolio are gradually tapering off. This, coupled with firm portfolio occupancy, led by proactive leasing management, should underpin the REIT’s earnings resilience and are early signs of a recovery in rental income. Maintain BUY with a DDM-based TP of HK$2.49.
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