CapitaLand Commercial Trust (CCT SP) - Negative Reversions Not A Surprise; Still Top Pick
Maintain BUY on top office REIT pick
- 1Q17 DPU is in line, at 27% of our FY17E.
- Although negative rental reversions at Six Battery Road bought down CCT’s portfolio passing rents, this has been well-flagged and should not jolt the market.
- We tweak our 2017-19E DPU by less than 1%. Reiterate BUY and SGD1.81 TP, at an unchanged yield target of 5.0%.
- CCT remains our preferred office REIT, with catalysts expected from a potential bottoming of the sector in the year ahead as the decline in office rents has slowed.
- Risks to our view include sharp retreats in office rents and cost overruns for redevelopment projects.
Negative rental reversions in line
- 1Q17 DPU of 2.40 SGD cts made up 26.5% of our FY17E forecast.
- Portfolio occupancy inched up 0.7ppt to 97.8%, led by CapitaGreen.
- Passing rents, however, marginally dipped to SGD9.18 from 4Q16’s SGD9.20 as rental reversions at Six Battery Road were negative. Signing rents at this property were SGD10.70-12.00 vs expiring rents of SGD14.17. We think the market already anticipated this.
- We have not built in conversion of its convertible bonds due in Sep 2017. Full conversion could dilute our DPU by 2.3%, though leverage could improve 2ppts to 36.1%.
Bottoming rents; potential recovery by 2018
- Preliminary estimates of Grade A office rents by CBRE suggest that the pace of rent decline slowed to 1.6% QoQ this quarter. We reiterate our view that office rents could bottom in early 2018 and recommend positioning ahead of this.
- Improving pre-commitments at new office buildings may translate into less pressure on landlords to discount rents to fill up properties.
Valuations remain attractive
- Even after a stellar 12% total return YTD, current unit price implies just SGD1,900 psf and a cap rate of 4.6% for its Singapore offices. These are lower than the replacement cost of SGD2,800 psf for a new office building and CBRE’s SGD2,700 psf estimate for the capital value of a Grade A office building.
- Appreciation in capital value of its properties.
- Successful redevelopment of assets such as Golden Shoe Carpark.
- Earlier-than-expected rebound in office rents.
- Sharper-than-expected declines in office rents or occupancy.
- Overpaying for acquisitions.
- Cost overruns in any redevelopment projects.