Today in addition to Keppel REIT releasing results, CCT also released the minutes of their AGM. Both events can help give investors an insight into what has happened in the office market and what we can expect going forward. This article will attempt to summarize some of the key points from the two releases.
1. Slower leasing and a shift to renewals
The pace of leasing has been slower as marketing and property visits have been postponed. CCT also mentioned that it has seen more renewals coming in as tenants want to minimize capital expenditure. Both CCT and KREIT cited that their high tenant quality was important in keeping occupancies high and allowing them to collect rents on time. There have also been no significant requests to downsize.
During this period, CCT highlighted flex space operators as being more affected as their members defer or waive memberships. This is usually highlighted as the downsize of flex space operators as they incur long term rent expenses but with short term membership revenues. On the bright side (for CCT), the WeWork lease at 21 Collyer Quay remains on track and there has been no indication of a withdrawal.
2. Earnings to weaken due to rental reliefs and higher expenses
KREIT cited rental reliefs as a reason for weaker property income. Zooming out a little, we expect NPI margins to compress due to higher cleaning and digitizing expenses incurred by office landlords in making their properties suitable for a return to work. While this is somewhat already expected, the investing community is still waiting on more specific guidance on how much earnings would weaken (similar to what the hospitality players have disclosed recently).
In their outlook statements, both KREIT and CCT mentioned that the impact is still hard to assess and they would continue to be prudent in distributions.
3. Demand down but supply is also lower
As generally known, demand for office space follows economic cycles and it is up to developers and urban planners to manage the supply of office space. While demand is expected to decline, Covid-19 has also resulted in construction and renovation works being pushed back and thus reducing new supply in the next few years. Furthermore, developers could also take the coming few years of weak demand to undertake redevelopments and asset enhancements at their properties. Examples of this are AXA Tower and Keppel Tower.
Overall while the impact from Covid is still limited to the first-degree impact from rental reliefs, I think that we can see higher vacancies and even negative rental reversions in the coming years as leases expire. Office demand will not collapse as fast as hospitality and landlords generally remain fairly positive about the long term potential of office. The slide below from Keppel REIT sums the discussion up quite aptly.
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