Keppel REIT - RHB Invest 2017-10-19: Negative Reversions Despite Bottoming Office Market

KEPPEL REIT K71U.SI

Keppel REIT - Negative Reversions Despite Bottoming Office Market

Keppel REIT (KREIT)'s 3Q results came in-line with expectations. However rent reversions for the quarter turned sharply negative (at c.-10%) despite a stabilising office market, which is a cause for concern.
Overall portfolio occupancy also slightly dipped by 0.2ppt QoQ to 99.6%.
In Australia, construction has commenced at 311 Spencer Street office tower in which K-REIT recently acquired a 50% stake. With gearing likely to cross the 40% level, we believe there is a possibility of equity funds raising in the near-term.

Keppel REIT (KREIT)'s 3Q17 DPU down by 13% YoY, results in-line. The lower DPU YoY was mainly due to a lower associate income, lower rent support and the absence of divestment gains (3Q16: SGD3m) received during the quarter.
For 9MFY17, DPU was lower by 13% YoY at SGD0.0427 (ie 4.27 cents). The 3Q/9M17 results were in-line with our expectations accounting for 24%/73% respectively.

For 9M17, Keppel REIT (K-REIT) signed c.0.53m sqft of office leases with overall rent reversions of -3%. This stands in contrast to 1H17 when K-REIT had signed 0.37m sqft of leases at flat (ie 0%) rent reversions, indicating negative rent reversions of c.10% during 3Q17.
The sharp negative rent reversions came-in despite an uptick in the overall Grade-A office rents (CBRE Group estimates a +2% QoQ in 3Q17), which is a cause for concern. The negative rent reversions also highlight management’s leasing strategy of maintaining occupancy amidst a huge in-coming supply.
With the recent lease renewals, K-REIT has minimal (0.5% of total NLA) due for renewal in 4Q17F. Overall, Singapore portfolio occupancy dipped by 0.2ppt QoQ to 99.6%.

Construction has commenced at 311 Spencer Street, Melbourne in which K-REIT acquired a 50% stake in Jul 2017 for AUD 347.8m (c.SGD362.4m). The completion of the Grade-A office tower is expected by 4Q19.
Upon completion, the building would be fully leased by Assistant Treasure (State of Victoria) on a 30-year net lease. The property comes with an average rental yield of 6.4% pa over the first 15 years.

The funding for the above acquisition would be done in tranches based on the construction progress, with K-REIT to make an initial deposit of c.AUD1.1m.
With K-REIT’s current gearing at 38.8%, a 100% debt funding would increase gearing above the 40% level and closer to the maximum allowable threshold limit. We believe in the future, management would consider all funding options, including a potential equity fund raising in order to lower the gearing.

While we expect rents in the Singapore office sector to bottom out this year and rebound by 5-10% in 2018F, we believe the positives are already reflected in the share price of KREIT. The stock currently offers a FY17F yield of 4.9% and trades at 0.9x P/B.
Key re-rating catalysts are a better than expected pick-up in office sector demand and a potential office property divestments at a good price.
Key risk is a structural decline in the office sector demand.

Vijay Natarajan RHB Invest | http://www.rhbinvest.com.sg/ 2017-10-19

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