Recovery for office Reits no tall order

The gleaming office towers in the heart of Singapore have well-hidden signs of trouble over the past two years. Falling rent and mounting vacancies have featured for consecutive quarters in these premium city offices, just as in suburban workplaces.

But as supply tapers and rent reaches its bottom, property analysts are predicting a recovery on the horizon, which bodes well for investors in office real estate investment trusts (Reits).

The Singapore Exchange (SGX) lists six office Reits -CapitaLand Commercial Trust, Keppel Reit, Frasers Commercial Trust, OUE Commercial Reit, Manulife US Reit and IReit Global - with a combined market capitalisation of $12.8 billion.

These six trusts have generated a market cap weighted average total return of 16.9 per cent in the year-to-date, said SGX in a June 20 report.

Their average gearing (the ratio of a company's debt to the value of its equity) of 34.4 per cent is also well below the limit of 45 per cent, which means that they keep financial expense liabilities in check.

FALLING RENT

Nonetheless, with an average dividend yield of 5.7 per cent, office Reits have performed slightly poorer than the average 6.4 per cent yield achieved by Singapore Reits (S-Reits). This could largely be due to falling rent.

A Colliers quarterly report in April noted that CBD premium and Grade A rents have dropped a cumulative 9.5 per cent since their peak in 2015.

Office buildings in Singapore are categorised according to their locations.

Grade A offices are located in the CBD; Grade B, in the city fringe; and Grade C, in suburban areas.

The portfolio of the six office Reits usually concentrate on Grade A buildings.

For instance, CapitaLand Commercial Trust owns several skyscrapers in the CBD, such as the 52-storey Capital Tower located in Robinson Road and the 42-storey Six Battery Road building in Raffles Place.

Keppel Reit has stakes in the 43-storey Ocean Financial Centre in Collyer Quay as well as Marina Bay Financial Centre, which consists of three office towers and an underground mall.

Investors should also note that office Reits are more sensitive to the state of the economy as well as business sentiment.

The Colliers report stated that overall business expansion has remained modest in the first quarter of the year, with expansions coming from IT and e-commerce-related companies.

On the bright side, there is demand from new players.

Co-working spaces are increasingly contributing to the demand for office space.

For instance, Chinese co-working spaces operator Distrii will lease more than 60,000 sq ft of space at Republic Plaza in Raffles Place early next year.

When ready, it will become one of the biggest co-working spaces in Singapore.

Another key driver affecting office Reits is the supply of office space.

Recent data by the Urban Redevelopment Authority (URA) showed that office space vacancy rates in the first quarter have reached the highest in five years, peaking at 11.6 per cent.

As a result, rent has suffered - the Singapore Office Rental Index fell by 3.4 per cent in the first quarter of the year, the ninth consecutive decline, noted SGX.

At the same time, supply increased this year, with the recent completion of UIC Building and Marina One, which are both in prime locations and will add 10 per cent to the CBD Premium and Grade A stock.

"As older buildings compete to backfill the space vacated by relocations to the new builds, we foresee CBD Premium and Grade A rents to soften by 2 per cent to 5 per cent this year," wrote Colliers' director and head of research Tricia Song.

The pressure on landlords will ease as the pipeline of office space is expected to stall soon.

URA data showed that office space supply is expected to peak this year, largely due to UIC Building and Marina One.In the next two years, there will be a shortage of supply until 2021 when two major projects will be completed.

They are Golden Shoe (CapitaLand Commercial Trust has entered into a joint venture with Mitsubishi Estate to redevelop it) with 800,000 sq ft of space, and Central Boulevard with 1.1 million sq ft of space.

Optimism in the industry is also going strong, noted SGX's report.

According to CBRE Research, office market deals are picking up with $3.39 billion worth of office deals transacted in the first four months of this year.

Recent deals include the sale of Asia Square Tower 1 to Qatar Investment Authority for a whopping $3.4 billion.

DBS Group Research noted in a June 22 report that investor scepticism over the value of Singapore's Grade A office buildings is unwarranted. Looking at land prices in recent transactions, it wrote that office Reits remain undervalued.Last month, the URA launched a commercial site in Beach Road for sale by public tender, with a minimum price of $1.138 billion. The tender will close in September.

RECORD

Last November, a plum 1.1ha land parcel in the Marina Bay area gathered seven bids, and the winning offer of $2.57 billion broke records.

Recent data by the URA showed that office space vacancy rates in the first quarter have reached the highest in five years, peaking at 11.6 per cent.

This surprised analysts who had expected the bids to be in the $1.54 billion to $1.8 billion range.

The DBS analysts estimated that the minimum land price of the Beach Road site implies a net lettable area (NLA) of $2,300 to 2,500 per sq ft.

They wrote: "Similar to the Central Boulevard site, the tender for the Beach Road land parcel highlights the undervalued status of the office S-Reits which are trading below replacement cost.

"The Singapore portfolios for the various office S-Reits, which are predominately located in the CBD or more prime locations compared to the Beach Road site, are currently trading on an implied price of $2,100 to $2,500 per sq ft of NLA."