Office REIT - CGS-CIMB Research 2018-10-30: Secular Office Upcycle Still Intact

CAPITALAND COMMERCIAL TRUST (SGX:C61U) SUNTEC REAL ESTATE INV TRUST (SGX:T82U) KEPPEL REIT (SGX:K71U)

Office REIT - Secular Office Upcycle Still Intact

Office SREITs 3QCY18 results demonstrated strength of the office upcycle.
URA data shows Grade A rents rising, Grade B rents picking up.
Our top office pick remains CapitaLand Commercial Trust, moving Suntec REIT up to second place.

Office REITs, with the exception of OUE Commercial Trust (SGX:TS0U), have reported their 3QCY18 results. Recent numbers demonstrated continued strength of the office rental upcycle. Portfolios remain well occupied, at 83.4-99%, although there were some frictional movements on a q-o-q basis.
With the exception of Frasers Commercial Trust (SGX:ND8U) and Keppel REIT (SGX:K71U) which showed y-o-y DPU declines largely due to loss of income from asset divestments, DPU of office REITs improved on a q-o-q and y-o-y basis even post equity raisings, mainly to fund new accretive acquisitions.

While rental reversions remained a little mixed, with Keppel REIT and Suntec REIT (SGX:T82U) enjoying positive reversions and CapitaLand Commercial Trust (SGX:C61U) still seeing some slight negative reversions, the negative gap continue to narrow q-o-q. Frasers Commercial Trust continues to feel headwinds from the Alexandra Technopark (ATP) where the space backfilling process is ongoing. With HP to vacate its remaining 93k sq ft (c.3.4% of portfolio NLA) at ATP in 4QCY18, we anticipate Frasers Commercial Trust’s earnings to stabilise only from 2019 onwards.
We believe office REITs would continue to explore inorganic growth opportunities, both in Singapore and overseas.

Urban Redevelopment Authority (URA) data showed that signing rents for Category A and B offices continued to rise 1.8%/1.1% q-o-q in 3Q18 (9M +9%/4.1%) while 484k sq ft of office space was taken up in 3Q (9M: 1.43m sq ft). A notable observation is that the speed of increment in Grade B rents has picked up q-o-q, rising 1.1% vs. +0.5% q-o-q in 2Q.
Island-wide occupancy rose to 87.8%. With minimal supply of 0.8m and 1.3m sq ft of new office space completing in 2019-2020, we remain positive on the office rental cycle.
Downside risks to our view include economic slowdown resulting from escalating trade tension, which would erode appetite for office space.

CapitaLand Commercial Trust has 14% of expiring portfolio income coming from its office leases in FY19 and 22% in FY20. This will enable the trust to renew into the rental upcycle. Expiring rents averaged S$10.70 psf in FY19 and S$9.55 psf in FY20 compared with CBRE’s average Grade A spot rents of S$10.45 psf in 3Q18. This should enable the trust to begin enjoying positive rental reversion in 2019, in our view.

We move Suntec REIT up to second preferred spot. We anticipate contributions from the new office and retail leases signed in 2H18 to impact SUN positively from FY19 onwards.
While we think Suntec REIT and Keppel REIT could likely experience some income volatility during HSBC’s relocation to MBFC2 from 2H19-Apr20, MBFC1&2 accounts for a smaller 17% of Suntec REIT’s 3Q18 property income vs. 22% of Keppel REIT’s income. Suntec REIT has a higher 10.9% of office NLA to be renewed in FY19, thus enabling then to ride the rental upcycle vs. Keppel REIT’s 7.6%. That said, we expect Keppel REIT to benefit from positive reversions when the remaining 7% of renewal/review leases in FY18 are re-contracted.

ADD, Target Price S$1.90.
CapitaLand Commercial Trust is the largest listed office REIT with AUM of S$11.1bn spread over Singapore (95%) and Germany (5%).

ADD, Target Price S$1.34.
Keppel REIT has S$8.5bn AUM of which 87% is located in Singapore and 13% in Australia, spread over 3.7m sq ft of attributable NLA.

ADD, Target Price S$2.06.
Suntec REIT has an attributable 4.76m sq ft of office, retail and convention space in Singapore and Australia, valued at S$9.6bn.

LOCK Mun Yee CGS-CIMB Research | EING Kar Mei CFA CGS-CIMB Research | https://research.itradecimb.com/ 2018-10-30

SGX Stock Analyst Report ADD MAINTAIN ADD 1.900 SAME 1.900

ADD MAINTAIN ADD 2.060 SAME 2.060

ADD MAINTAIN ADD 1.340 SAME 1.340