SINGAPORE (Feb 5): Singapore-focused office real estate investment trusts are being increasingly seen as a proxy for rising GDP growth. Their distribution per unit (DPU) yields are below 5%, yet their unit prices continued to rise last year. Perhaps they have risen too much — the largest office REITs did retreat somewhat in January. But, if the rental outlook remains positive, their asset valuations may rise further, propelling their net asset values higher.
For FY2017, CapitaLand Commercial Trust (CCT) was the outperformer among the REITs in general, giving a total return of 37%, according to its manager. Most of the gain was from the 30.7% rise in the unit price, with the rest from DPU yield based on the weighted average price as at Dec 31, 2016 and the rights issue price. Keppel REIT did well too. It gave its unitholders a price return of 23.5% last year, with a further 5.7% from its DPU yield.
However, both REITs reported declines in DPU for FY2017. For instance, CCT’s FY2017 DPU fell 13% to 8.66 cents, from 9.08 cents in FY2016. Keppel REIT’s DPU for the same FY fell to 5.7 cents, down 10.5% y-o-y.
A strong unit price has its merits, especially if a REIT plans on raising equity to fund acquisitions. Last year, CCT issued 513.54 million new units from a rights issue to raise $700 million and a further 122.7 million units from the conversion of $175 million worth of convertible bonds. If there is no significant dilution this year, its DPU could see some growth, negative rental reversions notwithstanding.
In October 2017, CCT announced the acquisition of Asia Square Tower 2. Its relatively low cost of capital helped it raise $700 million by issuing new units at just a 19.6% discount to its last traded price and a 17.3% discount to its theoretical ex-rights price. This was still dilutive to DPU.
The unit prices of both CCT and Keppel REIT have retreated from their highs, with CCT trading at a yield of just 4.63%, and Keppel REIT at a yield of 4.42%. Keppel REIT is now trading at a lower yield than the coupon of its 4.98% $150 million perpetual securities issued in 2015.
Perhaps this could be the year that Keppel REIT does a bit of capital management. Its annual cost of debt is 2.62% and its gearing is at 38.7%. It can now redeem the 4.98% $150 million of perpetual securities it issued in November 2015 and swap this for equity, bringing gearing down as it prepares to pay for an Australian acquisition. It need only issue about 119 million units, a mere 3.5% of its 3.37 billion units outstanding.
Bullish office outlook
Now, consultants are getting increasingly bullish about rental prospects for Grade A property in the CBD. This is positive for the future valuations for these two REITs. Valuers use rental outlook as one of the metrics by which they value investment properties.
“Grade A CBD rents are projected to increase by approximately 10% [in 2018] barring unforeseen circumstances,” says Christine Li, director of research at Cushman and Wakefield. In a report, Li points out that Grade A CBD office rent tracked by C&W grew 6.6% y-o-y last year to $9.20 psf per month, as compared with a decline of 6.9% in 2016. “With both the global and local economy on a firmer footing and business confidence strengthening, the pace of rental growth will accelerate in 2018,” she adds.
Kevin Chee, who took over as CEO of CCT’s manager last November, says 2018 may surprise. “Some of [the consultants] are pretty bullish about what 2018 holds,” he says. CBRE says Grade A rents in 4Q2017 rose 3.3% q-o-q to $9.4 psf pm. Consultants see this as a sign that the downward trend in Grade A rents has turned up decisively. ET&Co is similarly positive. “We anticipate rents to improve by 5% to 8% this year,” it says in a report.
The URA’s office price and rental indices for the central region in 4Q2017 posted a second consecutive quarter of increase and at a faster pace than in the preceding quarter. This is an indication that investors and occupiers are more confident that the upward price and rental trend in the office market will continue, Li of C&W says.
Office demand picked up substantially in the “downtown core region”, with net absorption (that is, the change in occupied stock) at 94,000 sq m of gross floor area in 2017, the highest since the 132,000 sq m in 2012. “The take-up rate of the new projects is phenomenal, with Marina One and DUO achieving 80% occupancy rate, while Frasers Tower and Paya Lebar Quarter secured 70% and 50% pre-leasing commitment respectively,” Li says. These projects are likely to reach almost full occupancy by end-2018, she adds.
Who is renting these offices?
Tan Swee Yiow, CEO of Keppel REIT’s manager, says 38.2% of its new leases in 2017 were from the technology, media and telecommunication sector. “Going forward, we anticipate TMT to be the largest sector, and a lot of companies’ expansion rate is quite mind-boggling. They take a space, then double and triple it because they’re driven by their business and they need to upscale it rapidly. So they will still account for the largest sector but other sectors are also experiencing positive growth.”
Banking, insurance and financial services came second, and accounted for 14.6% of new leases committed at Keppel REIT’s properties, which are the choicest in the CBD — Ocean Financial Centre, one-third of Marina Bay Financial Centre (MBFC), and one-third of One Raffles Quay (ORQ). Real estate and property services was the third largest sector for new leases last year. “What is significant is that demand is not coming solely from one sector, but from different sectors, so it’s more-broad based,” Tan says.
Surprisingly, banking, insurance and financial services accounted for CCT’s top leases signed in 2017, followed by TMT, energy and commodities, and maritime and logistics. “We have a pipeline of different types of tenants. One area is co-working, consultancy and energy and we’re measuring what makes the best sense for the space we have left,” Chee says. This year, only 7% of its leases by gross rental income is up for renewal, including the recently acquired Asia Square Tower 2.
According to C&W Research, shadow space rose to 172,000 sq ft last year, compared with an average of 112,000 sq ft over 2014-2016. “Although it looks high, we are of the view that these older spaces will eventually be taken up by cost-conscious tenants who are unable to afford prime office rents. The backfill tenants for the older spaces have a diversified profile, including financial services, technology and professional services,” Li says. A couple of co-working operators are new to Singapore. These are Distrii from China, which is taking up space in Republic Plaza, and US-based WeWork, which is leasing space in 71 Robinson Road and Beach Centre.
ET&Co says the current market landscape makes it ripe for older commercial buildings to be redeveloped. “We anticipate more interest, especially for the collective sales of commercial buildings.” Redevelopment would shrink the supply of office space further in the near term. Next year, only 556,000 sq ft of new supply will come into the market and none of it in the core CBD area.
No longer about DPU yield
What does this bullish outlook have to do with unit price? Investors always look to the future, which is why the prices of CCT, Keppel REIT and also Suntec REIT were on a tear last year. The various property transactions only spurred their prices higher, and this is despite falling DPUs and CCT’s rights issue. In the absence of pure-play office property companies, investors are buying the REITs as a proxy to both quicker GDP growth in Singapore and the region, and the local office market.
CCT alone was responsible for some “cap rate compression” in the office sector. Capitalisation rates are the yields at which income is capitalised in an investment property. It is the ratio of net property income to property value. Last year, CCT divested 50% of One George Street at a cap rate of just 3.2%. Interestingly, the remaining 50% stake was valued at a cap rate of 3.7% as at Dec 31, an indication of CCT’s conservative valuation metrics. The REIT also divested Wilkie Edge, a fringe, non-Grade A property at a cap rate of 3.4%.
Yet, CCT was able to acquire Asia Square Tower 2 at a cap rate of 3.6%. In 4Q2017, Chevron House fetched $2,526 psf. Li of C&W says the relatively high price was achieved due to improved sentiment on the back of stronger rental recovery. “In comparison, Asia Square Tower 2, a trophy Grade A+ asset in the heart of Marina Bay, only fetched 2,689 psf in 3Q2017.”
CCT’s buildings were valued at cap rates of between 3.6% for Six Battery Road, a 999-year leasehold property, and 4.10% for fringe office Raffles City Office Tower and CapitaGreen, which has a shorter land lease period of 56 years.
Keppel REIT’s cap rates were almost uniform at 3.75%. Suntec REIT’s were at 3.75% for its one-third stake in ORQ and MBFC, and 4% for Suntec City Office (see table).
Even if cap rates for these properties remain unchanged over the course of the year, rental outlook — based on the very low supply for this year and next — is likely to keep capital values buoyed.
Profiles of Singapore-focused office REITs
CapitaLand Commercial Trust (CCT) is probably the cream of the crop. From just $2 billion when it was listed as a dividend-in-specie by CapitaLand, it has grown to have an asset size of $10.5 billion. It owns the choicest buildings in the CBD, including two 999-year leasehold buildings. According to Kevin Chee, CEO of CCT’s manager, the real estate investment trust owns more than 20% of the Grade A buildings in the CBD, making it arguably the largest office landlord. It also has the most efficient REIT in its fee structure, and a pipeline of a super-Grade A property in the redevelopment of Golden Shoe Car Park. If risk-free rates rise, and unit prices fall, this must surely be the REIT to consider investing in. One more observation: Its buildings are valued below those of the other office REITs.
Keppel REIT had a stranglehold on the best properties in Marina Bay until CCT bought Asia Square Tower 2. Its sponsor, Keppel Land, was one of a trio of developers that built One Raffles Quay and the Marina Bay Financial Centre properties. Keppel Land also redeveloped what is now Ocean Financial Centre, another Grade A+ office building. Some 87% of the REIT’s net property income (NPI) is from Singapore, with the remainder from Australia, where long leases and freehold status provide stability for unitholders.
OUE Commercial REIT’s major properties are One Raffles Place and OUE Bayfront. It also owns Lippo Plaza in Shanghai. It reported a 9.8%% decline in distribution per unit for FY2017 to 4.67 cents, translating into a yield of 6.2%. The DPU decline was due to an enlarged unit base from an equity placement completed in March 2017. It underperformed last year, rising just 3% compared with the large-cap office REITs.
Suntec REIT is seen mainly as an office REIT because office contributed 68% to its NPI of $244.5 million in FY2017. Retail — largely from Suntec City Mall — accounted for 27% of NPI, and convention centre for 5%. Its Singapore office portfolio contributed 56% to NPI while Australia office contributed 12.2% to NPI. Although investor attention was focused on CCT and Keppel REIT, Suntec REIT’s unit price rose some 30% last year. Based on its DPU of 10.005 cents for FY2017, unchanged y-o-y, DPU yield is around 4.83%. Interestingly, it is the only commercial REIT that has not asked its unitholders for a rights issue or equity fundraising since its IPO in 2004, not even during the global financial crisis. Since then, this REIT has returned 128% in DPU and has more than doubled from its IPO price of $1.
