Rating: Buy (price target: S$1.72)
We see signs of recovery in the office sector. Interest from larger tenants (banks, financial services and wealth management companies) has been growing as they seek to leverage low rents to consolidate operations. The sweet spot for demand appears to be floor plates of 20,000 sqft and below. We expect demand drivers to continue to come from legal services, multinationals setting up regional headquarters in Singapore, as well as insurance and wealth management companies. Consultants we spoke to are also more confident on the leasing outlook. We believe rents have troughed, and that the pace of recovery will gain momentum through 2014.
We forecast Grade A rental growth to S$9.80psf for 2013 and S$10.20psf for 2014. Capital values should find support at S$2,450psf, based on a 4% net cap rate, which we think is reasonable versus transactional cap rates at 3.2%. Fears over excessive new supply in 2013 were overblown, with the bulk absorbed by the market. For 2014, supply appears more benign, with only 1.5m sqft of new completions (which would add 1.8% to inventory), versus 2.6m sqft in 2013. Grade B rents and demand should continue to hold up well as the flight-to-value theme plays out. Ho Bee’s The Metropolis is a case in point, and the 1.1m sqft development is already 95% leased, with asking rents in the S$6+psf/month range. We think 2014 should be no different.
We like CapitaCommercial Trust (CCT) for its pure play exposure. The risk in 2014 is the lease up of its 700,000sqft CapitaGreen as it progresses towards completion in Q414. Management is asking for rents of S$10-12psf versus S$9.55psf for other Grade A assets, and does not intend to trade rents for occupancy. We think the reason is because other than Asia Square Tower 2, there is limited availability of Grade A office space in the Marina Bay area. This creates a window of opportunity for CCT to lock in tenants and drive higher rents.
Within the existing CCT portfolio, we think management will continue to focus on pushing up occupancies at One George Street, which has experienced significant volatility as tenants relocate to newer assets in the CBD. Among its assets, we expect CCT to deliver positive rental reversions on lease renewals other than at Six Battery Road, where expiring leases are S$10.93psf.
Positive office data points on rents and leasing, and strong pre-commitments at developments such as CapitaGreen, could lead investors to take a renewed interest in CCT and the office sector. From a macro perspective, earlier-than-expected tapering of QE in the US could lead to interest rate volatility and potentially negatively impact the share price.