During a webinar on June 21, S&P Global Ratings analysts believe that rising stress from vacancies and higher funding costs in APAC office properties are manageable for most of their (S&P’s) rated office REITs.
Even then, RBA has followed the Federal Reserve by raising interest rates at an accelerated pace. Inevitably, this will cause capitalisation rates to rise, and valuations to decline, note the analysts at S&P.
“Our view is that the price discovery process will lead to resetting of office base valuations. For instance, Dexus finalised the sale of 44 Market Street (in Sydney) to PAG, a Hong Kong private equity group at a 17.2% discount to book,” notes Aldrin Ang, director, S&P. A Dexus announcement says the agreed transaction value of A$393.1 million reflects a 17.2% discount to the building’s valuation as at December 31, 2022.
“Australia is no exception to what the wider APAC region is experiencing. Heightened interest rates are contributing to cyclical challenges, and there could be additional pressure on valuation,” Ang reasons.
“Development has restarted and we expect supply to outstrip demand for office space and evidenced by vacancy rate in CBD,” Ang continues, referring to the Australian cities of Sydney and Melbourne. “We expect vacancy levels to remain elevated. Incentive levels remain high coming out of the pandemic and we expect them to remain in the current pattern as landlords seek to lock in tenants.”
On the other hand, buildings with flexible workspace, end-of-trip facilities and strong tenants will be able to support rental income streams, and buffer Australian REITs from falling rent, Ang adds.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
In Singapore, work-from-home (WFH) is less disruptive as employees are returning to office 2-3 days a week. A recent JLL report found that Asia has the highest return-to-office levels versus the rest-of-the-world, with Singapore and Hong Kong at the highest return-to-office rates compared to pre-pandemic levels.
In a stress scenario, if 40% of leases don't renew at expiry, Australia and Singapore are the most resilient markets in terms of funds from operations or FFO divided by debt. Singapore office landlords can withstand up to 15% in valuation decline before aggregate leverage levels challenge the regulatory limit, the S&P analysts reckon. S&P covers just one S-REIT with office properties, CapitaLand integrated Commercial Trust (CICT).
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
According to CICT’s FY2022 results presentation, including its joint ventures, its total debt is around $10 billion. If its valuation, which stood at $24.2 billion as at December 31, 2022, fell by 17%-18%, its aggregate leverage would be approaching the regulatory limit.
As at end-FY2022, CICT had significant downward revaluation of a property in Germany. In 2018, CICT had acquired a 94.9% stake in Gallileo in Frankfurt for the equivalent of $577.4 million. As at December 31, 2022, Gallileo was valued at $370.2 million.
In a footnote in its FY2022 presentation, CICT attributed the valuation decline of Gallileo to the impending departure of Commerzbank in January 2024, provision of capex and downtime for upgrading works, as well as an expansion of discount rate from 5.15% to 6.50%. Terminal yield increased from 2.95% to 3.15%. To date, CICT’s manager has not announced plans for the building.
In 2019, CICT acquired 94.9% of Main Airport Center for the equivalent of $387.1 million. As at December 31, 2022, this property was valued at $358.1 million.
Early last year, CICT completed the acquisition of two office properties in Sydney, 66 Goulburn Street, and 100 Arthur Street. It remains to be seen if the Dexus transaction impacts these two properties. CICT’s overseas portfolio constitutes about 7% of its portfolio property value.
According Ang, June valuations in Australia saw a 7.7% decline compared to prior book values. However, he adds that Australian office remains an attractive asset class. And, as evidenced by the Dexus transaction, offshore capital is entering the market for office. Other S-REITs with notable Australian predominantly office properies are Keppel REIT K71U (17.2% of AUM in Australia) and Suntec REIT (16.7% of AUM in Australia).
As far as Singapore is concerned, Ong Hwee Yee, an analyst at S&P, says CICT has sufficient buffer against a valuation decline to the aggregate leverage limit of 50%. In addition, CICT has proven to have disciplined financial management, with levers to reduce gearing and other debt metrics, although it could be challenging to raise equity, she adds.
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Additionally, CICT's Singapore office portfolio metrics are sound. Occupancy for 1Q2023 was 96.7% and the office portfolio recorded a positive rent reversion for year-to-date end-March 2023 of 4.2%.
For the office sector in general, Ong highlights that supply of 2.3 million sq ft for this year is the highest over a 5-year period. “Bargaining power tilts in favour of tenants,” she says, adding that in 1Q2023, rental growth moderated and vacancy inched up.
APAC marches to a different beat
Overall, the S&P analysts highlighted that APAC office metrics are somewhat different from US office. For one thing, WFH while available is not as entrenched as in the US. This is because commute time in APAC’s dense cities is shorter than in the US.
For instance, the average commute time in Sydney and Melbourne averages 45 minutes to an hour compared to an average of two hours in US gateway cities. In the US, eating at home is a lot cheaper than eating out during office hours. Additionally, funding is available in Asia, and local banks remain flush with liquidity.
Bloomberg Intelligence has highlighted that Singapore banking sector’ total deposits y-o-y growth of about 4% in April 2023 outpaced that of total loans y-o-y growth of minus 6%. “The liquidity surplus in the banking sector underscores how Singapore is a beneficiary as Asia’s wealthy shift their money to a perceived safe haven,” Bloomberg Intelligence says.
In China, the People’s Bank of China has been lowering its lending rates. On June 19, the one-year loan prime rate (LPR) was lowered by 10 basis points to 3.55%, while the five-year LPR was cut by the same margin to 4.20%. On June 15, the medium-term policy loan rate was lowered by 10 bps to 2.65%.
