(July 29): On July 18, CapitaLand Commercial Trust’s placement units — to raise $220 million, most likely to partially pay for Frankfurt Main Airport Center — were snapped up in less than half an hour, and pricing was tight. CCT’s acquisition of a 94.9% stake in the building costs €251.5 million (about $387.1 million). The building’s initial net property income (NPI) yield is likely to be 4%.
An office upcycle, in which rents are rising, coupled with falling global interest rates and low local risk-free rates, created the strong demand for CCT’s placement. Despite the demand, there is some unease among investors about a recently signed seven-year lease with WeWork that will commence in 2Q2021 for the entire building at 21 Collyer Quay. CCT owns eight predominantly Grade A office properties in Singapore and one Grade A office property in Frankfurt.
WeWork filed for an IPO with the US Securities and Exchange Commission last December, but so far, nothing has materialised. WeWork was recently valued at US$47 billion ($64 billion) in a private fundraising round, making it one of the most valuable private companies in the world. However, WeWork is loss-making. Investors have questioned its business model of short-term leases and rental agreements compared with its longer-term loan agreements. In January, SoftBank Group’s Vision Fund scaled down its investment in WeWork from US$16 billion to US$2 billion, wire services reported.
According to Jill Smith, CEO of Manulife US REIT’s manager, valuers in the US are likely to assign lower valuations to a property if co-working space makes up more than 20% of the asset. This is because companies operating co-working space are viewed as start-ups, which have less robust credit profiles.
The 999-year leasehold 21 Collyer Quay was valued at $462.2 million, or $2,306 psf, as at June 30, and its capitalisation rate is 3.5%, unchanged y-o-y.
WeWork does not have a break clause with CCT, which means it cannot get out of paying for its lease should it decide to leave the building earlier than 2028. All it can do is sublet the space.
The current tenant, HSBC, which has a triple net lease on a 14-year rental contract, is moving to Marina Bay Financial Centre (MBFC) Tower 2 next year. CCT has not disclosed the rent that HSBC is paying, but it is estimated to be $6.70 psf a month.
CCT has also not disclosed the rent -WeWork is likely to pay, but it could be higher than the current rates at 21 Collyer Quay. “We will revert back to normal lease [terms] at market rent. A normal lease structure allows us to have a better handle on maintaining the property, and we will take over the management of the property. There is rental escalation. It is a fixed step-up, based on agreed rents over seven years,” says Kevin Chee, CEO of CCT’s manager.
Musical chairs
Keppel REIT and Suntec REIT each own one-third of MBFC Tower 2, with the remaining third in the hands of Hongkong Land. Keppel REIT owns stakes in office buildings in Singapore and Australia and recently acquired an office building in Seoul. Suntec REIT owns office buildings in Singapore, including Suntec City, and Australia. Despite the good news of a new anchor tenant at MBFC Tower 2, Keppel REIT and Suntec REIT are grappling with a couple of large tenant moves. UBS is moving out of One Raffles Quay — also owned by Keppel REIT, Suntec REIT and Hongkong Land —where it occupies 230,000 sq ft, or 17% of net lettable area (NLA), and Suntec City, where it occupies 90,000 sq ft. UBS is moving to 9 Penang Road (former Park Mall), owned by a Suntec REIT joint venture with SingHaiyi Group. “We are confident that we will be able to re-lease the space as [it occupies] the highest floors in the North Tower and has an excellent view of Marina Bay,” says a spokeswoman for Keppel REIT’s manager, when asked about the soon-to-be vacated space.
On July 7, Deutsche Bank announced that it was planning some 18,000 job cuts globally by 2022 and is likely to right-size its operations in Asia-Pacific, including Singapore. This implies that it will give up space at its current headquarters in One Raffles Quay, where it occupies seven floors (200,000 sq ft, or 16% of total NLA). “Deutsche Bank’s lease expires in 2025 and we have not been approached by it regarding any change in requirements,” a spokeswoman for Keppel REIT says.
“[Deutsche Bank] will not be able to return the office space, but can sublease some of its existing space,” notes a recent update by RHB Securities. RHB also observes that the vacated space has received strong interest.
Standard Chartered Bank’s lease at CCT’s Six Battery Road expires in 2020, but it will remain an anchor tenant. The bank is also an anchor tenant at MBFC Tower 1, where it has naming rights. “We are at an advanced stage of negotiations with the bank to take up office space and flagship [branch] space [at Six Battery Road],” Chee said at a recent results briefing.
Both CCT and Keppel REIT aim to strike a balance between a diversified tenant base and long weighted average lease to expiry for stable income. Both REITs still have a significant portion of their portfolios by gross rental income (GRI) or NLA leased to banks, with five banks among the 10 tenants for CCT (HSBC, Commerzbank, Mizuho Bank, JPMorgan and Standard Chartered Bank) and Keppel REIT (DBS Bank, Standard Chartered, BNP Paribas, UBS and ANZ).
For CCT, banking contributed 24% to GRI, followed by financial services (11%). Hospitality contributed 9%, as did energy, commodities, maritime and logistics (as one sector). Companies in the banking, insurance and financial services occupied 36.8% of Keppel REIT’s portfolio by NLA, followed by those in technology, IT, media and communications (11.9%) and government agencies (11.4%).
Active leasing, acquisitions to mitigate disruptions
According to Keppel REIT in its 2QFY2019 results announcement, its tenant retention rate was 64%, and it completed 272,900 sq ft of leases during 1HFY2019. As at June 30, Keppel REIT’s committed occupancy stood at 99.1%, higher than the Grade A office average of 95.8% and CCT’s 98.4%.
In 2QFY2019, CCT signed more than 257,000 sq ft of new leases and renewals, of which 25% were the former. New demand for office space was driven by tenants from diverse trade sectors, including banking, consultancies, IT, media and telecommunications, and retail products and services. In FY2018, the retention rate of CCT’s portfolio was 77%.
Keppel REIT’s manager says half of the committed leases are new leases and expansions from tenants mainly in the technology, media and telecommunications, banking and financial services sectors, while the remaining committed leases are renewals and rent reviews. “Almost all leases concluded in 1HFY2019 were in Singapore. The average signing rent for the Singapore office leases committed was $11.93 psf a month, above the Grade A core CBD market average of $11.30 psf a month,” Keppel REIT’s manager said in a statement.
On May 27, Keppel REIT completed the acquisition of T Tower, a 28-storey, 228,000 sq ft, freehold Grade A office building in the Seoul CBD, for KRW252.6 billion ($301.4 million). According to Keppel REIT’s manager, the building is a five-minute walk to Seoul Station, and is “well-positioned to benefit from potential capital value appreciation and rental growth amid steady leasing demand and limited upcoming supply”. It is 100% leased and its NPI is around 4.7%, which the manager says is distribution per unit (DPU)-accretive.
Elsewhere, 311 Spencer Street, a Grade A office building in Melbourne, will be ready in 1H2020. In 2017, Keppel REIT announced that it had acquired a 50% stake in the building for A$347.8 million (which at the time was the equivalent of $368 million). NPI yield is 6.4% and it will be fully leased to an Australian government agency for 30 years.
“While the portfolio will remain anchored by prime CBD assets in Singapore, we believe that having assets across Singapore, Australia and South Korea will enhance geographical and income diversification, as well as provide greater stability and further opportunities for growth in the long term,” the spokeswoman for Keppel REIT’s manager says.
Despite initiatives in leasing and acquisitions, Keppel REIT’s distributable income in 1HFY2019 fell marginally to $94.6 million (1HFY2018: $96.6 million), owing to a lower one-off income received from the early surrender of leases, absence of rental support in 2QFY2019 and the impact from the divestment of a 20% stake in Ocean Financial Centre.
AEIs at CCT
CCT’s acquisition of Main Airport Center is likely to be 1% to 2.5% DPU-accretive, depending on funding. NPI from the acquisition should offset some of the decline from 21 Collyer Quay when HSBC vacates the building in 2Q2020.
“For 21 Collyer Quay, it was an entire evaluation about what we do with the asset after HSBC occupied it for 14 years. Based on market occupiers looking for space, we decided to take the opportunity to upgrade the building,” Chee says, referring to the $45 million CCT plans to spend on asset enhancement initiatives (AEIs) to bring the building to Green Mark GoldPLUS rating. NPI yield on cost is 9%.
Since AEIs and fit-out for WeWork will be completed in 2Q2021, 21 Collyer Quay is likely to start contributing to NPI only in 2H2021.
AEIs will also be carried out at Six Battery Road in 1Q2020 and be completed in 3Q2021. It will be business as usual for the office space, Chee says. CCT will spend $35 million on the AEIs and expect a yield on cost of 8%.
Subject to authorities’ approval, the enhancement will include a new 24/7 through-block link connecting Raffles Place to the Singapore River that will feature new F&B offerings. A rooftop restaurant with views of the Singapore River and flexible workspace will also be added. The building will remain operational during the AEIs.
“Capitalising on the opportunity to refresh the building, we will have a brand-new façade that will glitter like a gem during the day and glow like a lantern during the night. We will introduce a high-end restaurant on the fifth floor, which is rooftop space. In 2013, our AEI of $85.8 million to the tower block and lobby had a return on investment of 8.6%. Alongside the AEI, we were able to maintain strong occupancy and high rents and what we are doing for the podium [next year] is a continuation of this,” Chee says.
Providing unitholders with a sustainable and growing DPU is foremost among the manager’s considerations, Chee has maintained in previous briefings. “We have not guided for any capital distribution, but we will work at minimising short-term DPU impact [from 21 Collyer Quay]” he says. Says Anne Chua, CFO of CCT’s manager: “We have also shared our tax-exempt income, which includes $40.7 million from [compensation for] Bugis Village and we have not decided how to use those funds. We have been consistent and we try not to manage DPU artificially. If we have extracted value from divestments, we can do a little bit of top up. More important is to focus on the business rather than prop up DPU.”
In 2QFY2019, CCT announced a 1.9% y-o-y rise in DPU to 2.2 cents, and a 2.8% y-o-y rise in DPU to 4.4 cents for 1HFY2019.
Keppel REIT announced a 2.1% y-o-y decline in DPU in both 2QFY2019 and 1HFY2019 to 1.39 cents and 2.78 cents respectively.
Analysts are split down the middle on their recommendations for both REITs. CCT has nine “buy” and nine “hold” recommendations and five “sell” calls. Credit Suisse has an “underperform” (the equivalent of “sell”) rating for both -REITs, while OCBC Investment Research has a “sell” call on CCT and a “hold” recommendation on Keppel REIT. The latter attracts seven “buy”, six “hold” and five “sell” calls.
At annualised or projected forward yields of around 4.1% for CCT and 4.5% for Keppel REIT, investors may decide to wait until yields are at more reasonable levels.
Suffice to say that the quality of the managers are well proven and the local properties in the portfolios of both REITs are among the best Grade A properties in the CBD.
In addition, CCT has managed to make good acquistions overseas. Gallileo in Frankfurt’s banking district is one of the tallest (Grade A) buildings in the city and leased to Commerzbank. The latest acquisition, Main Airport Center, is just 1km away from Frankfurt Airport. No surprise then that its units were in such demand on July 18.
