Singapore Office REITs - DBS Research 2016-06-07: Paying for Quality

SGinvestors.io

KEPPEL REIT K71U.SI SUNTEC REAL ESTATE INV TRUST T82U.SI CAPITALAND COMMERCIAL TRUST C61U.SI OUE COMMERCIAL REIT TS0U.SI FRASERS COMMERCIAL TRUST ND8U.SI

Singapore Office REITs - Paying for Quality

• Landmark transaction in downtown CBD has positive implications for Singapore as an investment destination and office REITs
• Likely valuation floor achieved for Grade A office; downside to NAVs for office REITs likely to be limited
• CCT and K-REIT to be beneficiary if a rebound in office REITs occurs

What’s New

Deal sealed for prime office tower in downtown Singapore. 

• The well-anticipated sale of Asia Square Tower 1 happened today with sovereign wealth fund, Qatar Investment Authority (QIA) picking up the 43-storey Grade A office building from US private equity firm BlackRock for a record US$2.45 billion (S$3.4 billion).

A new record size. 

• The sale represents the largest single- tower real estate transaction in Asia Pacific to date, and the second largest single-tower real estate transaction globally. 
• The deal is also the biggest in Singapore in terms of dollar amount and square footage with QIA paying US$1,960 (S$2,667.5) psf.

Asia Square Tower 1

• Asia Square Tower 1 is located in the Marina Bay financial district, Singapore’s equivalent to London’s Canary Wharf or Shanghai’s Lujiazui. It comprises more than 1.2 million sqft of office space and nearly 40,000 sqft of retail area. 
• Current tenants of Asia Square Tower 1 include financial services companies Citibank and Julius Baer as well as insurance firm Marsh & McLennan. 
• JLL has been the sole leasing agent and property manager of Asia Square since it opened in June 2011.

Our View

Singapore remains an attractive investment location backed by SGD being a store of value for investors globally. 

• QIA is going ahead with the transaction although vacancies could rise to c. 20% in the near term (it was reported that Google will be vacating at the end of the year). This reflects its confidence in continuing to attract tenants given the building's Grade A specifications. Based on an assumed rent of close to S$10psf, the price implies a net operating income yield of 3.1%.
• We reckon that QIA is taking a longer-term view in acquiring this property which is located in the downtown Marina Bay Area. The market is facing an oversupply situation over 2016- 2017 with an expected 4 million sqft of space entering the office market. However, given the tightening stance by the government on commercial land sales in recent years, the pipeline of office buildings completing in 2019-2020 is minimal. This is expected to result in another supply squeeze in the medium term.
• In addition, we believe that the relative strength and stability of the SGD would have made global investors look at Singapore as a destination to invest in.

This transaction is positive for Office REITs 

• This transaction is positive for Office REITs in our view as the transacted price of S$2,667 psf is above Keppel REIT, Suntec REIT, CapitaLand Commercial Trust and OUE Commercial Trust’s current implied prices of S$2,289 psf, S$2,100 psf, S$1,800 psf, and S$2,380 psf respectively, based on our estimates.
• The closest peers to the underlying transaction are Keppel REIT and Suntec REIT, both of which own office buildings nearby.

Office sector to still feel pressure on rents; but valuations should remain fairly sticky for now. 

• While we believe that the office sector is not out of the woods yet, this landmark transaction will likely provide a pricing floor for valuers to take into account in the upcoming valuation exercise at the end of 2016. As such, we believe that cap rates are unlikely to expand much in the near term and office REITs are likely to see fairly stable NAVs in this stage of the office cycle.
• Active retention of key tenants has been observed from most office landlords and hence, portfolio net operating income (NOIs) should remain fairly stable despite the negative rental reversions expected.

BUY on dips. 

• While not out of the woods yet with further expected declines in market spot rent, the transaction of this prime office property is, in our view, one of the key data points that will signal a gradual bottoming of the office REITs. 
• We believe that the office REITs are attractive at an average P/NAV of 0.8x, offering a yield of 6.7%. 
• CCT and K-REIT are key beneficiaries on a rebound in interest in office names.

Derek Tan DBS Vickers | Mervin Song CFA DBS Vickers | http://www.dbsvickers.com/ 2016-06-07

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