Singapore Office REITs - Maybank Kim Eng 2020-12-15: Working In A New Normal ~ Fundamentals Weak; Work-From-Home A Structural Negative


Singapore Office REITs - Working In A New Normal ~ Fundamentals Weak; Work-From-Home A Structural Negative

Initiate Keppel REIT, Suntec REIT at SELL

  • Singapore office REITs have outperformed peers year-to-date, but we expect this trend to reverse in 2021 due to weak fundamentals. Recessionary conditions have dampened leasing demand, while macro uncertainties have reduced visibility on corporate expansion plans and office space needs.
  • We are cautious on potential structural demand erosion with the adoption of WFH (work-from-home) practices, which could offset gains from de-densifying offices, and temper an already slow macro-led net absorption trend.
  • Office vacancies are on the rise, and with rents pressured, we initiate coverage on Keppel REIT and Suntec REIT at SELL, with 19-21% downside to our DDM-based target prices.
  • Gearing has risen after recent deals, limiting headroom for acquisition-growth opportunities, relative to industrials.

Structural headwinds with work-from-home entrenchment, tenant downsizing

  • Against the recessionary backdrop, businesses across an array of industries are looking to curb costs and defer non-essential capital expenditure, with many downsizing through renewals or relocations. At the same time, firms are assessing office space needs as they ease out from the pandemic.
  • Financial institutions and professional services firms will be the most willing to implement work-from-home arrangements in our view, as they trim office space needs with a larger proportion of their staff working remotely.
  • We assume CBD office occupiers could aim to reduce their footprint by 10-20% over three years, and estimate demand to fall by 0.5-1.0m sf pa from 2020-22. This compares to the average of 1.1m sf of net absorption in the past decade.

Demand weak with recessionary headwinds, U-shaped recovery

  • We expect leasing momentum to slow further, and estimate net office absorption of -1.0m sf in 2020, with occupiers holding back on expansions and business sentiment staying cautious as firms struggle with weaker revenue.
  • We estimate net absorption will gradually improve to 0m sf in 2021, and +1.0m sf in 2022 as the economy rebounds, bringing net absorption to zero from 2020-22. This is slower than the improvement seen in 2004, and also below the average annual net absorption of 1.0m sf from 2015-19, as Singapore’s GDP recovers at a modest +4.5% in 2021 and +3.0% in 2022 from the contraction of -5.7% in 2020.
  • We do not expect the recovery in GDP to correlate to a pick-up in office demand, as the increase in productivity would have been alongside greater work-from-home adoption and lower office demand.

Work-from-home arrangements to support flexible space demand

  • The silver lining in rising work-from-home adoption is the increased demand for flexible space, which currently occupies c.5% of Singapore’s office stock, and has scope to grow.
  • On our estimates, Singapore’s office density has risen to 105 sf, but could reverse as occupiers could require 15-20% more space for social distancing according to Cushman and Wakefield, as workers return to the office with the easing of lockdown measures.
  • De-densification could help mitigate the reduction in demand as more work-from-home, but this is likely insufficient, as occupiers will be reluctant to increase operating expenses against a weak growth environment, and with Singapore’s office space already 44% under-utilised pre-COVID, we expect firms will more likely adopt a wait-and-see, retaining current capacities, ahead of committing to additional leases.

Supply thin, with no net additions till 2023

  • After factoring in the elimination of office stock by 3.0% (or 2.0m sf) due to redevelopment projects, we estimate no new net supply till 2023. While this is the lowest level of net supply against a recessionary overlay, we note that removal of supply largely represents Grade B office stock or those at fringe CBD locations, where rents are at a significant differential to those of Grade A offices.
  • As such, we believe it is likely for occupiers that are displaced by potential redevelopment activities to relocate to other fringe CBD locations or business parks. The latter is currently seeing high vacancies of c.15%, therefore leaving much room for traditional office space occupiers as they move to older business parks properties.

Rents to fall 15% through 2020-21

  • We forecast rents for Grade A office to decline by a further 5% in 2021, after falling 10% in 2020, then rising by 5% in 2022. This is on the back of weak demand at least until 2H21, and with increasing work-from-home and tenant downsizing offsetting near-term gains from social distancing measures and thin supply.
  • We expect the rental decline to be underpinned by island-wide vacancies, which have edged up from 10.5% in 4Q19 to 12.0% in 3Q20 on the back of the slowing economy, and which we expect to widen to 13.0% through 2022.

Limited acquisition catalysts, prefer industrials

  • Leverage for Keppel REIT and Suntec REIT would have risen to c.37% and c.43% respectively after their recent acquisitions, higher than their large-cap peers at 34-39%, and this could limit their debt capacity to fund further deals. At the same time, the high forward dividend yields for office REITs, which are above the 3-5% cap rates for prime office assets globally, could limit opportunities for DPU-accretive deals.
  • We believe it will be challenging for office REITs to raise equity to fund acquisitions, as they are trading at below 1x P/B. While this would reflect concerns on declining office rents and potentially lower capital values, we also see limited scope for asset recycling, or at the least, we think this would likely have a neutral DPU impact given weak pricing power in this cycle.

Recommendations on Singapore Office REITs

We initiate on Keppel REIT (SGX:K71U) at SELL with a DDM-based target price of S$0.90 (COE: 7.1%, LTG: 1.0%).

We initiate on Suntec REIT (SGX:T82U) at SELL with a DDM-based target price of S$1.20 (COE: 8.2%, LTG: 1.0%).

We reinstate coverage on CapitaLand Integrated Commercial Trust (SGX:C38U) at BUY with a DDM-based target price of S$2.50 (COE: 5.9%, LTG: 1.5%).

Reports on Singapore Office REITs 

Chua Su Tye Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2020-12-15
SGX Stock Analyst Report SELL INITIATE SELL 1.200 SAME 1.200