Tuesday, September 10, 2013

Office REITs: Rents bottoming out (OCBC)

Office REITs: Rents bottoming out
Mixed bag of headline numbers in 2Q13
Office REITs displayed a mixed set of performance on their headline numbers in 2Q13 as a few of them have undergone through major overhauls in their portfolio and capital structure. For example, Frasers Commercial Trust (FCOT) saw its NPI decline 13.4% YoY due mainly to the divestment of KeyPoint and its Japan properties, but its DPU jumped 28.5% on lower interest costs and distributions following the redemption of its Convertible Perpetual Preferred Units (CPPUs). Suntec REIT, on the other hand, suffered a 38.5% YoY drop in NPI as part of its crown jewel Suntec City Mall and Suntec Singapore were closed for AEI works. However, distributions to unitholders were cushioned by a capital distribution of S$7.8m from Chijmes sale proceeds. As a result, aggregate NPI for the office REIT subsector fell 11.4% YoY in 2Q13, while the subsector DPU increased by 5.1%.

Positive underlying performance; likely to improve further
Despite the mixed bag of results, improved operational performance was seen across the board. Healthy rental reversions were registered among the office REITs during the quarter, whereas the subsector occupancy rate inched upwards QoQ to 98.2%. We note that office REITs have been particularly active in their leasing activities, due possibly to the more lumpy nature of the lease renewals. In particular, FCOT made significant progress at China Square Central and 55 Market Street in Singapore with the filling of new tenants, thereby pushing the occupancy rates at the buildings up to 91.7% and 100% respectively. In addition, FCOT completed the early renewal of 511,000 sqft of space expiring in FY14-15 at Alexandra Technopark. Over at Suntec City, Suntec REIT has also forward-renewed 102,000 sqft of office leases due to expire in 2014. This has helped the office REITs enhance their income stability and lengthen the subsector average WALE to c. 4.9 years from 4.8 years in 1Q.

Gearing ratio maintained at acceptable level
On the capital management front, the office subsector gearing ratio edged up 1.7ppt QoQ to 37.7% in 2Q13, but is still within acceptable level in our view. This was mainly due to a spike in FCOT’s aggregate leverage over the quarter following its CPPU redemption. However, the borrowing costs eased to 2.6% from 2.8% in 1Q13 on the back of interest savings from refinancing of loans at more favourable terms. Debt duration also improved to 2.8 years after factoring in Suntec REIT’s refinancing of all its borrowings due in Oct 2013 with its recentlyacquired 5-year loan facility.

Office rental decline moderated
For the rest of 2013 and 2014, we are keeping our optimistic stance on the office rental market. The subsector has weathered through a cycle of changing fortunes over the past few years, with office rentals continuing its downturn since the inflection point in 3Q11. However, we note that the rate of decline has moderated over the past few quarters, and 2Q13 Grade A and B office rents are now flat QoQ at S$9.55 and S$7.10 psf pm respectively, based on CBRE 2Q13 Real Estate market report figures.

In addition, the office space continued to see steady net absorption of 268,316 sqft in 2Q13, which resulted in the CBD Core sub-market and Decentralized sub-market recording significant increases in the occupancy rates to 95.1% and 98.0% respectively.

Positive tone on office outlook
Based on these positive developments, we now believe that the office market may just be on the cusp of a recovery, given that the office leasing activities are still expected to remain healthy going forward. As a note, CBRE expects occupier demand to remain positive across most industries except for possibly the traditionally dominant financial industry. For 2H13 till 2016, CBRE projects that there is a total of 9.12m sqft of potential office space supply (17.4% of current stock), with no major developments in 2015. As such, CBRE expects the office rents to stay relatively stable in 2H13 and possibly strengthen in 2014.

Staying OVERWEIGHT on office REIT subsector
The tone set by office landlords on the office outlook also appears to be more positive, as opposed to a quarter ago. Office REITs are generally very involved in enhancement works which should help them command better rental rates post completion of the projects. In addition, several office buildings within the office REITs’ portfolios are currently underrented, and are well-positioned to capture the potential upturn of office market recovery upon lease renewal. Valuation-wise, office REITs also look increasingly appealing, given that the subsector is trading at one of the lowest subsector P/B of 0.82x and forward yield of 6.6%. In view of this, we are staying OVERWEIGHT on the office REIT subsector. We are also retaining CapitaCommercial Trust [BUY, FV: S$1.61] as our top pick for the office space due to its strong proxy for local office market recovery, lowest gearing of 28.9% and respectable forward yield of 6.1%. We also like Suntec REIT [BUY, FV: S$1.80] for its strong growth potential, unjustly-depressed P/B of 0.73x and attractive yield of 6.9%..

Source/Extract/Excerpts/来源/转贴/摘录: OCBC-Research,
Publish date: 09/09/13

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