Suntec REIT - UOB Kay Hian 2022-09-07: London Properties Have Recovered & Provide Stable Contributions

SUNTEC REAL ESTATE INV TRUST (SGX:T82U)

Suntec REIT - London Properties Have Recovered & Provide Stable Contributions

Suntec REIT (SGX:T82U) opportunistically acquired Nova Properties and Minster Building in London during the COVID-19 pandemic. London has weathered Brexit, the COVID-19 pandemic and the switch to hybrid working. The recovery in take-up for office space was broad-based but was strongest for the West End at 24% above the 10-year average.

Suntec REIT’s recovery was driven by office and retail properties in Singapore as London accounted for only 11.5% of portfolio valuation. Maintain HOLD.

Take-up in Central London totalled 3.8m sf in 2Q22, an increase of 123% y-o-y and 24% above the 10-year average. It was a strong quarter for pre-letting, which accounted for 10 out of 11 leases of more than 50,000 sf in size. There is flight to quality as occupiers prefer new and high-quality office space.
Take-up for office space has rebounded back to pre-COVID-19 levels. The recovery was broad-based but was strongest and fastest for the West End. Take-up for the West End during the past 12 months was 24% higher than the 10-year average. The recovery was driven by the financial services sector, especially in the core markets of Mayfair and St James.
According to Cushman & Wakefield, prime office rents have increased by an average of 7.2% over the past 12 months (City Core: +9.3%, West End: +8.8%, East London: unchanged).

CBRE has analysed leasing data for Central London during the past 12 months. Occupiers moving to new office spaces on balance are increasing their space requirements. There are more tenants expanding than tenants contracting. CBRE surveyed 68 tenants who executed new leases. Of these, 39 tenants took up more office space compared to 29 who downsized.
The study demonstrated that hybrid working did not reduce demand for office space.

The UK government plans to overhaul regulations to reclaim London’s title as the busiest financial centre in the world. It intends to ease regulations for banks, insurers and fund managers to reinvigorate the financial services industry post Brexit. Regulations on a wide range of services from IPOs to green finance must be rewritten to replace existing EU regulations.
Potential new regulations include reducing the amount of cash reserves that insurers need to hold and providing flexibility for insurers to invest in infrastructure projects. Regulators will also be made accountable to a secondary objective of promoting economic growth.

Suntec REIT completed the acquisition of 50% interest in two Grade-A office buildings with leasehold tenure of 1,042 years under Nova Properties at the West End for £430.6m (S$766.5m) on 18 Dec 20. The property provides a yield of 4.6%.
Suntec REIT subsequently acquired a Grade-A 999-year leasehold Minster Building in the heart of City of London for £353.0m (S$667.2m) on 28 Jul 21. The property provides a yield of 4.5%.
The two properties accounted for 11.5% of Suntec REIT’s portfolio valuation. The UK portfolio provides stable contribution with long WALE of 10.1 years. Suntec REIT has borrowings of £375m denominated in Pound Sterling, which provides natural hedge of 47%.

Melbourne saw buoyant leasing activities but actual tenant expansion has been modest because large corporations are still assessing efficient usage of office space in response to hybrid working. Higher cost of construction has put upward pressure on rents for new developments, which allows landlords of existing office buildings to raise rents. Net face rent has increased 3.9% y-o-y and 0.4% q-o-q to A$684/sqm/year. Incentives have eased 20bp q-o-q to 40.4%.
Yield has compressed 10bp y-o-y to 4.66%. Vacancy has deteriorated 2.6ppt y-o-y to 12.9% as new supply has outstripped net absorption.

The authorities have approved the planning control amendments to enhance the retail podium and develop a new office tower at Southgate Complex. Management is reviewing the planning parameters to determine the optimum mix between office and retail space.
Suntec REIT could consider:
- divesting Southgate Complex with the approved redevelopment plan, or
- selling Southgate Complex to a JV company to redevelop Southgate Complex.

Suntec REIT's aggregate leverage remains elevated at 43.1% as of Jun 22. It is vulnerable to higher interest rates as 56% of its borrowings are hedged to fixed interest rates. Management expects financing cost to reach near 3% by end-22.
See
Every 50bp increase in base rates is expected to reduce Suntec REIT's distributable income by 4.7%.
We maintain our existing DPU forecast and HOLD recommedation on Suntec REIT.
Catalysts to Suntec REIT's share price include:
- Positive rent reversion at Suntec City Office in 2022.
- Employees returning to work at Suntec City Office and resumption of events at Suntec Convention could trigger recovery in shopper traffic and tenant sales at Suntec City Mall.
- Full-year contributions from Minster Building in London, UK, in 2022.

Jonathan KOH CFA UOB Kay Hian Research | https://research.uobkayhian.com/ 2022-09-07

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