Office REITs results round up: WFH a boon or bane?

by - January 30, 2021

Over the past few weeks, S-REITs have been announcing their results for the quarter ended 31 Dec 2020. Out of the few sectors (Retail, Office, Industrial and Hospitality), REITs with exposure to the Singapore office market have finished announcing their results. The article will broadly summarize what the key takeaways have been for me and also highlight some of the catalysts that investors in such REITs can look out for. Most of these REITs have non-SG Office exposure too but the focus will be on SG Office since that is the key exposure (apart from CICT). 

Suntec REIT

In previous years, SUN had a significant portion of distribution that was capital in nature; this was absent in FY20. However, it seems like there was guidance from management during the briefing that such capital distributions could be used to keep DPU stable in FY21 as SUN recovers from the retail and conventions (~13% of NPI) fall out. 

Most of the decline in portfolio valuation (-1.8%) was driven by the mall and convention space. Suntec City office, ORQ and MBFC declined by 1.2/0.6/0.8% respectively. Not too worrying as I think valuers imputed weaker reversions in the near term. 

On the office front, SUN guided that there would be continued pressure on rents as companies turn cost-conscious. The pace of renewals was also expected to slow as downsizing was expected. Only about 20-30% of the workforce has returned to their offices. Nonetheless, SUN expects positive rental reversions to continue especially driven by the UBS lease at ORQ which seems to have been done at <$8.50 according to JPMorgan. This can explain the divergence in occupancies and rents seen in the chart below. Typically we would have expected higher occupancies and lower rents as landlords try to fill up their space in a downturn. 

As for growth and catalysts, 2021 would see the absence of rental reliefs and full contribution from:

  • 21 Harris Sydney acquired in Apr 20
  • 477 Collins St Melbourne completed in Aug 20
  • Nova Properties UK acquired in Dec 20
  • 9 Penang Rd Singapore
On the flipside, DPU is expected to be impacted by negative reversions at its mall and convention centre and overhang from its high gearing of 44.3% and low ICR of 2.6x (in 2022 REITs would need ICR of >2.5x to have a gearing of >45%). Analysts are forecasting a DPU yield of around 5.3-5.8% on the back of ~10-15% growth for FY21. 

Suntec City Office Committed Occupancy and Passing Rents (Source: Suntec REIT)

Keppel REIT

KREIT had a 2.7% yoy improvement in DPU due to contributions from T Tower and Victoria Police Centre but offset by rental reliefs and divestment of Bugis Junction Towers. Looking ahead, analysts expect DPU yield to be around 5.0% DPU growth will be driven by:
  • Victoria Police Centre (2H20 onwards)
  • Pinnacle Office Park (Dec 20 onwards)
  • Keppel Bay Tower (2Q 21 onwards)
KREIT highlighted that most of its new leasing was from Banking & Finance (36.5%) and Real Estate (34.2%) which doesn't seem entirely in line with news reports of tech companies being the largest new demand sector. The TMT sector contributed 13.5% to KREIT's new leasing demand but 34% to Suntec's new leasing demand. So maybe OFC just doesn't attract tech as much as Suntec City office if we ignore the overseas assets. Nonetheless, management continues to expect positive rental reversions as expiring rents ($9.76 in 2021 and $10.26 in 2022) are still lower than new signing rents ($11.02). 

Valuations declined by 1.6/1.8/1.1% for OFC, MBFC and ORQ respectively. Diving into the numbers, I am intrigued by the MBFC and ORQ ones as the declines are more than that of what Suntec experienced for their stake in MBFC and ORQ. Putting them beside one another so that readers can compare. Not sure if I missed anything important that could explain this difference. 
Suntec Valuations (Source: Suntec REIT)

KREIT Valuations (Source: Keppel REIT)

During the briefing, management guided that it was continuing to look for acquisitions in Australia and Korea and could scale back unit buybacks to conserve capital. It seems there is also potential for KREIT to partner with its Sponsor to redevelop Keppel Towers. Not very sure if gearing of 39.0% (post acquisition of Keppel Bay Towers) is a concern considering KREIT also has pseudo-debt in the form of perpetual which could increase debt by 10% so maybe around 43% gearing if we include it. 

OUE Commercial REIT

OUECT is the only one in the office REIT space that continues to have a retention of distributable income. 11m of distributable income was retained, 6m of which was for working capital for their hospitality segment. This is understandable as hospitality continues to be badly hit and they are also looking at closing Mandarin Orchard for a rebranding to Hilton. 

Like Suntec and KREIT, OUECT experienced positive rental reversions for its SG office spaces and expects such positive reversions to continue albeit at a slower pace as committed rents were still above expiring rents. Management highlighted that there could be transitional vacancies as leases expire but overall should still be fairly stable. The largest tenant, Bank of America also recently renewed their lease at OUE Bayfront and would remove an overhang. 

Following the divestment of 50% of OUE Bayfront, DPU could be weaker yoy due to the income vacuum. There would also be lower hospitality revenue once MOS is shut for rebranding. Based on disclosures, it seems like the proceeds from divestment could be used to pay down debt (41.2% now but 34.5% if paid down) or distributed to unitholders. To me this is not positive as it indicates a lack of capital recycling opportunities from the REIT and also not conducive for DPU. It is giving up 3.6% yield (using cap rate as a proxy for yield) to save on 3.0% cost of debt resulting in a net loss of 0.6% income on the capital. OUECT already doesn't have the best reputation due to its dilutive fund raising a few years back and also Sponsor that is linked to the Riady family that has backed First REIT and LMIRT. 

I think it will continue to trade at a discount to its peers due to i) reputation of sponsor and ii) exposure to hospitality. On a trailing 12M basis, it trades at around 6.2% yield, while its peers are trading at sub 6% yields. 

CICT

Finally, the to the largest REIT in Singapore, CICT. Took >2hrs to read through the slides and listen to the webcast. Since the work has already been done, I will also touch on retail a little. 

For Office, leasing momentum has picked up over the past few quarters as tenants have a clearer picture of what a post-Covid-19 world will look like. 86% of new demand was from financial services. This also underscores the idea that financial services will still demand high quality offices more than tech firms which can go to business parks or city fringe. 

Looking at the graph below from CICT, we can tell that market rents have passed their peak in late 2019 and are gradually going on a downtrend. While I do not expect the trough of rents to fall below $9.00 psf, I think the decline will be long drawn as office landlords are still reporting positive reversions from lower base rents entered into during the upcycle. 
Market Rents across time (Source: CICT)

On retail there were a few key concerns by analysts. 1) Is the worst over? 2) Tourism impact for tenant sales 3) Reversions and 4) New retail. It appears that the worst is over and we would not go back to 2Q2020. Tourists used to account for maybe about 20%+ of tenant sales for downtown malls. Reversions would still be negative going forward to support tenants and ensure that there is a good mix of tenants conducive for shoppers. 

For DPU growth, it would be driven by the completion of:
  • CapitaSpring (2H21)
  • Lot One AEI (2H21)
  • 21 Collyer Quay (4Q21)
  • 6 Battery Road (4Q21)
This could be offset by additional AEIs that the REIT Manager undertakes during the year as well as divestments. From the sound of it, I'm not sure if JCube could be divested as it seems like it doesn't really have a strong value proposition when trying to compete against JEM and Westgate which are attached to the MRT and have everything. 

Summary

Overall I think that office REITs' growth has to be driven by inorganic growth as there is little room for organic growth. Organic growth will be held back by tenants giving up space and negotiating shorter leases. On the flip side, shorter leases could be positive if the cycle bottoms out soon as that would give landlords more negotiating power if leases end on an upcycle. From a tenant perspective, it really doesn't make sense to be leasing the same amount of space when you only can have a maximum of 50% of your workforce back. I think the shift will be to co-working concepts that allow companies to do a core+flex strategy to optimize rental costs. With greater prevalence of co-working, that could also imply lower rents for landlords since co-working operators take up large volumes of space. 

As most office REITs have gearing of >40% (KREIT is 39%), there is also a small 'risk' of equity fund raising to bring this down. I think what could be prudent for REITs to do is to do a fund raising together with an acquisition and 'over-raise' a bit to bring down gearing. So on a net basis the acquisition is less accretive than it could have been but still accretive to DPU. 

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