Keppel REIT’s Singapore assets make up much of the city-state’s CBD skyline as it owns a one-third stake in Marina Bay Financial Centre and One Raffles Quay, and 79.9% of Ocean Financial Centre.
To DBS Group Research, Keppel REIT stands out for its best-in-class office portfolio, which is anchored by the Grade A offices in prime locations in Singapore. As the only pure-play Singapore REIT (S-REIT), the REIT’s portfolio offers a value that REIT investors “have yet to appreciate”.
For investors, Keppel REIT also stands out because it is one of only two S-REITs that has an active unit buy-back programme that has met with a positive response from investors. In 1H2023, Keppel REIT bought back 19.65 million units in 1H2023 of which 10.15 million units were bought back in 2Q2023.
Unit buy-backs are positive for Keppel REIT as its net asset value (NAV) is at $1.31 as at June 30, and its distribution per unit (DPU) yield based on its 1HFY2023 DPU translates to 6.6% based on the average buy-back price of around 87.5 cents. This makes the buy-back accretive to DPU.
“Keppel REIT had undertaken a DPU-enhancing unit buy-back exercise at an average estimated price of $0.875 and cancelled 19.65 million units (0.5% of [its] total issued units) in 1H2023,” notes a recent CGS-CIMB report. The report says Keppel REIT’s management wants to maintain “its flexibility in utilising unit buy-backs and capital distributions as part of its capital management strategy as well as managing its gearing level.”
As at June 30, Keppel REIT’s gearing is at 39.2%, which may curtail the REIT’s ability to continue with its buy-back programme. In April this year, Keppel REIT’s mandate from its unitholders on its unit buy-back programme enables the manager to buy back 10% of units in issue or 375.5 million units.
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According to Keppel REIT’s rationale, the unit buy-back mandate is a flexible and cost-effective capital management tool to enhance ROE and DPU. “When exercised at appropriate times, the buy-back mandate would help mitigate short-term market volatility, offset the effects of short-term speculative trading of the units and bolster market confidence in the units.”
A DPU-enhancing model
Since Koh Wee Lih was appointed CEO of Keppel REIT’s manager in December 2021, he has focused on capital management. In January this year, Keppel REIT announced a special distribution of $100 million over the next five years leading up to its 20th anniversary in 2026. Keppel REIT will distribute $20 million annually which unitholders will receive on a semi-annual basis.
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In addition, to keep funding costs as stable as possible, Keppel REIT’s hedge ratio has increased since Koh came on board. “We have increased our interest rate hedge ratio from 63% as at end-2021 to 71% at the end of first quarter of FY2022. The hedge ratio was subsequently maintained at around 75% and ended at approximately 76% at the end of FY2022,” Koh says.
He has also managed to maintain Keppel REIT’s low cost of debt during the year although that is likely to increase as the months wear on. “For example, before the interest rate hikes, in 2019 and 2021, we issued 5-year convertible bonds and 7-year medium-term notes (MTN) at very attractive rates of 1.9% and 2.07% respectively,” Koh says.
In October 2022, Keppel REIT acquired KR Ginza II in Tokyo, a freehold office building comprising eight storeys of office space and a retail unit on the ground floor, offering a total net lettable area (NLA) of 3,427.1 sqm. In July 2023, a new tenant from the energy sector committed to three floors in KR Ginza II, bringing the committed occupancy from 36.3% to around 75 %. When fully leased, the property is expected to bring a net property income (NPI) yield of approximately 3.1% and pro forma DPU accretion of 0.5%.
“For our recent Japan acquisition, we have entered into interest rate swaps to fully hedge our interest rate exposure which fully protects us from the recent Bank of Japan’s position to increase its cap on the long-dated interest rate curve,” Koh continues. “Our all-in cost of debt of 2.84% per annum for 1H 2023 is lower when compared to the prevailing reference rates, which is a testament to our effort in managing our borrowing costs.”
Nonetheless, CGS-CIMB expects funding costs to rise - as they have with most S-REITs. “In terms of funding cost, at the current interest rate level, average funding cost could trend closer to mid-3%.”
Australian foothold
Keppel REIT was one of the first Singapore-focused REITs to expand overseas, to Australia. Its first Australian acquisition was as far back as 2010 when Keppel REIT acquired 77 King Street in Sydney and 50% of 275 George Street, Brisbane. In 2016, the REIT divested 77 King Street, and in 2021, divested 275 George Street. It now owns six Australian properties.
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Diversification often reduces risk in a portfolio. Still, the Australian dollar has weakened against the Singapore dollar by more than 30 Australian cents (26.3 cents) since then. Some market watchers expect a rebound in the Australian dollar should Chinese demand return.
The weaker Australian dollar versus the Singapore dollar was evidenced in the six months to June 30 by the 3.5% decline in valuation of the Australia portfolio in Singapore dollars compared to a 1.1% gain in valuation of the Australian portfolio when valued in Australian dollars for the period between Dec 31, 2022 and 30 June, 2023.
“In terms of geographical diversification, Keppel REIT’s portfolio is and will continue to be anchored by assets in Singapore which represents 79% of our portfolio as of June 30. We believe having 25% - 30% of overseas assets complements Keppel REIT’s Singapore-centric portfolio and increases Keppel REIT’s ability to deliver stability and sustainable growth through property cycles in individual countries,” Koh says.
A couple of Keppel REIT’s Australian properties have single-tenant leases with long weighted average lease expiries (WALEs). “The single tenant leases that we have are in Australia, and these are with the Australian Government. David Malcolm Justice Centre in Perth is leased to the high court for 25 years, and Victoria Police Centre in Melbourne is leased to the police department for 30 years. Both leases have fixed annual rental escalations and rent review at pre-determined anniversaries,” Koh says.
Diversified tenant and asset base
Other than that, Keppel REIT has a diversified tenant base of more than 440 tenants. Many are blue-chip corporations including global and local banks. Financial institutions such as banks rank among the largest tenants followed by government agencies. DBS, BNP Paribas and Standard Chartered are among the top 10 largest tenants by NLA. The State of Victoria accounts for 9.8% of NLA, and the Government of Western Australia comprises 4.1% of the REIT’s NLA.
“Our Singapore assets are operating at very high committed occupancies with Ocean Financial Centre and One Raffles Quay at 100% occupancies, while Marina Bay Financial Centre and Keppel Bay Tower are at more than 98% occupancies,” Koh says.
In Australia, however, there was some concern over vacancies. Out of six properties in Australia, 8 Chifley Square, Pinnacle Office Park, and Blue & William - all in Sydney - have committed occupancies of 87.4%, 90.2% and 37.7% respectively as at June 30.
For his part, Koh says the performance of the Australian portfolio has improved on a q-o-q basis with 8 Chifley Square and Blue & William securing new tenants.
“We embarked on a fitted-out office concept [in Australia] a couple of quarters back and have received strong interest from prospective tenants. With fitted-out offices gaining popularity amongst the tenants as they can move into the office within a shorter time frame, we are looking at doing more fitted offices to further increase our leasing velocity and occupancy,” Koh explains.
“Currently, we have fitted out office space in 8 Exhibition Street and Pinnacle Office Park. We are looking at having more fitted offices for the other floors at Pinnacle Office Park, as well as rolling it out to other assets such as Blue & William,” he adds.
Overall, the REIT’s strategy seems to be working with the manager having committed a total of over 850,000 sq ft of space at a “healthy rental reversion of 8.1% in the first half of 2023”.
“The weighted average signing rent for our Singapore office leases increased from $12.05 psf per month in 1QFY2023 to $12.35 psf per month in 1HFY2023, reflecting steady demand for prime office space,” Koh says. The portfolio committed occupancy overall was 94.9% as at June 30.
When asked about the tenant risk, Koh says the creditworthiness of tenants is assessed prior to signing of lease agreements. “We maintain a proactive approach to monitor the tenant credit risk exposure and ensure mitigation measures are in place should the risk impact become material. Credit risks are further mitigated through the upfront collection of security deposits. Systematic rental collection procedures are implemented to ensure regular collection of rents, thereby minimising rental arrears and default risk,” he adds.
Among the office REITs and mixed REITs, Keppel REIT has been among the best performers, losing less than 6% this year despite a significant Australian presence.
“In terms of inorganic growth, acquisitions remain challenging in the near term with negative spreads between cap rates and funding cost in the majority of its geographic footprint, with the exception of Japan,” CGS-CIMB says. That may be a good thing. The market frowns upon acquisitions because accretion is challenging, and equity and cost of capital in general are expensive.
Keppel REIT is probably in a good place as it finds its own units to be the best value from an acquisition standpoint.
It is also said to be in a favourable position to capitalise on a potential recovery in a tight net supply market, which is expected to last till 2024, says DBS Group Research.
