Singapore REITs - RHB Securities 2015-09-01: Not Yet For Bottom-Fishing (Office Sector)

Singapore REITs  Office Sector 

Office: Fears For Large Supply in 2016 

  • The share price performance of office REITs has been hit the worst among the SREITs sector thus far – having tumbled 24.8% YTD. We think that the market has been cautious on the office segment as there are concerns over a large office supply (~3.9m sq ft) coming through the market next year. The anxiety for large office supply in 2016 is despite all office REITs maintaining high occupancy levels and achieving high positive rental reversion up to 27.2%. 
  • For the past two years, the office rental market has seen higher rental growth rate mainly due to the crunch in office supply. However, looking a year forward, we do not think that office REITs will be able to sustain a high growth rate. We note that the rental growth rate has already been slowing down, which implies that demand for Grade A offices has already slowed down in the latest quarter. Given the large supply of ~3.9m sq ft of office space in the pipeline due next year, we think that the rental growth rate is most likely to face stronger headwinds. 
  • According to the statistics provided by the Urban Redevelopment Authority (URA), the average annual net demand from 2005 to 2014 was 1.0m sq ft, while from 2010 to 2014, demand was 1.2m sq ft. Assuming average annual demand of 1.1m sq ft from 2016 to 2018, it would require more than four years to allow the market to absorb the huge supply. Due to the abundance of supply and a slowdown in demand, we think the rental rate of SGD11.40 psf/month has peaked in 1Q15. 
  • Currently, average rental rate has edged down to SGD11.30 psf/month, booking in slower growth rate for the quarter. Given the weak global and Asian economic environment today, we are expecting occupancy levels to drop drastically as the huge office supply flows into the market. 
  • Likewise, we are expecting office REITs to book in negative rental reversion as rental rates for grade A offices should slide > 15% by end-2016 from current levels. 
  • Despite the lacklustre office sector, we prefer office REITs with exposure to Grade B offices such as Frasers Commercial Trust, mainly attributable to its: 
    1. high resilience, and 
    2. expectations for higher rental growth rates for Grade B offices due to tight Grade B office supply. 
  • On its growth story, we think that Grade B offices are poised to achieve higher rental grow rates as new supply is virtually zero from 2016 to 2018. All incoming supply is to be built within the core central business district (CBD) region. 
  • While both Duo and GuocoTower would be situated within the fringe CBD region, we have categorised the two buildings as Grade A offices due to their new building facilities. Likewise, these two buildings have very large floor plates of approximately 30,000 sq ft, which do not directly compete with Grade B offices such as Frasers Commercial Trust’s China Square Central and 55 Market Street. 
  • Grade B’s rental and occupancy rates have been very stable in relative to Grade A’s. In the midst of a volatile and fragile economic environment, we prefer REITs with a higher defense mechanism. 
  • Given the: 
    1. large office supply over the four years, and 
    2. weak global economic environment today, 
    our team downgrades our recommendation for the office REITs sector to UNDERWEIGHT from Neutral, as we expect office landlords to face increasing challenges to fill up vacancy, and rental rates to fall >15%, resulting in negative rental reversion. 
  • With the above factors, we downgrade CapitaLand Commercial Trust, Keppel REIT and Suntec Real Estate Investment Trust to SELLs (from Neutral) with DDM-derived TPs of SGD1.15, SGD0.86 and SGD1.31 respectively, from SGD1.52, SGD1.13 and SGD1.75. 
  • Our only preference within the office sector is Frasers Commercial Trust, while we maintain NEUTRAL on the remaining REITs within our office REITs coverage.

Ivan Looi | Ong Kian Lin | http://www.rhbgroub.com/ RHB Securities 2015-09-01
SELL Downgrade NEUTRAL 1.15 Down 1.52
SELL Downgrade NEUTRAL 0.86 Down 1.13
SELL Downgrade NEUTRAL 1.31 Down 1.75
BUY Maintain BUY 1.71 Same 1.71