Keppel REIT - UOB Kay Hian 2016-07-20: 2Q16 Leasing Sails Forward Despite Sector Headwinds

Keppel REIT - UOB Kay Hian 2016-07-20: 2Q16 Leasing Sails Forward Despite Sector Headwinds KEPPEL REIT K71U.SI 

Keppel REIT (KREIT SP) - 2Q16: Leasing Sails Forward Despite Sector Headwinds

  • Results were in line with expectations. 
  • Proactive leasing efforts saw forward renewal of most leases due in 2016. 
  • Average rents signed in 2Q16 were still above market average. 
  • Management expects flattish to marginal positive rental reversions going forward. 
  • Aggressive execution, coupled with flight to quality to its super prime offices, should tide KREIT through choppy waters when supply headwinds threaten in 2H16. 
  • Maintain BUY with an unchanged target price of S$1.31.


Results in line. 

  • Keppel REIT (KREIT) reported 2Q16 DPU of 1.68 S cents/share (-4.2% yoy, -4.1%% qoq). 
  • Property income and NPI saw respective declines of 5.6% yoy and 6.5% yoy, attributable to the loss of contribution from 77 King Street (divested early-Jan 16). 
  • The decline was slightly offset by JV and associate income from One Raffles Quay and Australia. 
  • The drop in 2Q16 DPU was also partially attributable to the additional dilutive effects of the Distribution Reinvestment Plan with 11.1m units issued in 2Q16. 
  • Results are in line with expectations, with 1H16 DPU representing 49.5% of full-year estimates.


Enthusiastic forward renewals to minimise tenant flight risk. 

  • KREIT has aggressively forward renewed the bulk of its expiring leases due in 2016 and 2017, with just 0.6% and 9.5% by NLA remaining respectively. This would minimise tenant flight risk during the next wave of commercial supply due in 2H16, from the likes of Guoco Tower (1.3m sf in 2016), Marina One and Duo (2.4m sf in 2017). No rental incentives have been dangled to entice.

Moderating rental reversions. 

  • With overall reversions (new, renewal and forward renewals) in 1H16 amounting to +2%, this implies negative 2Q16 reversions (1Q16:7%). 
  • Management indicated that the quarter saw a wide variance of rental reversions (ranging from -20% to +12%), with negative reversions mainly from banks which signed on at previously higher rates. 
  • We understand that KREIT’s portfolio average passing rents range from S$8.50 to low S$9 psf pm for leases due from 2016-18, thus implying up to 12% headroom to current Grade-A rentals (S$9.50 psf pm). 
  • Management also indicated that there is positive demand for space with enquiries streaming in weekly, a far cry from the post Global Financial Crisis period.

Resolute optimism from management.

  • Despite softening rental reversions, management continues to guide for flattish to marginally positive reversions going forward, pointing to the historical premium of 4-8% in rents signed compared with spot rents. We also note that KREIT continues to command a premium over market rents, achieving average committed rents of S$10.10 in 2Q16 (average CBRE Grade-A rent in 2Q16: S$9.50 psf pm).
  • While Marina One still remains about 30% pre-leased, (tenants include Virgin Active, Cold Storage), tenant flight from KREIT’s Grade A portfolio seems unlikely from management’s view, in terms of cost-benefit. The REIT manager has also observed healthy demand from Asian banks, legal and government agencies technology media and telecommunications, as well as small but nascent demand from the fintech sector. We opine that Grade-B commercial space still remains most at risk from flight to quality as Grade-A rents continue to slide.
  • Continued easing in the office segment. Office rents saw continued easing in 2Q16, the fifth consecutive quarter of contraction. According to CBRE, Grade-A office rentals declined a further 4% qoq in 2Q16 to hit S$9.50 psf pm (1Q16: S$9.90). This represents a 16.6% decline in rentals from 1Q15’s peak of S$11.40 psf pm. With this also being the fourth consecutive quarter of negative islandwide office space absorption, landlords are likely to have compromised on rental to retain new tenants or attract new ones. We are thus heartened by KREIT’s ability to retain nearly all of its tenants.
  • Expect further softness before pick-up. We expect a 10-15% correction in office rents this year before a potential recovery post supply digestion next year. Beyond 2018, commercial supply remains meagre at below 0.65m sf (Frasers Tower).


  • None.


  • Maintain BUY with an unchanged target of S$1.31, based on DDM (required rate of return: 6.7%, terminal growth: 1.7%).


  • Higher office rentals.
  • Positive newsflow on leasing activity, employment and economic growth. 
  • Slower rise in interest rates.

Vikrant Pandey UOB Kay Hian | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2015-07-20
UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.31 Same 1.31