Office REITs – UOBKH

Leveraging on positive rental reversion

Blessed are the office landlords. Rentals for prime office space within Raffles Place and Marina Centre has shoot up from S$8.60 in 1Q07 to S$15.00psf pm in 4Q07. Rentals for Grade A office space is even higher at S$17.15psf pm in 4Q07 (source: CB Richard Ellis). Rentals surged as tenants chased after limited pockets of vacant space within the Central Business District. There is strong demand from financial institutions (wealth management, hedge funds, insurers and commercial banks) and oil & gas companies. Average occupancy for Grade A office space at Raffles Place, Shenton Way and Marina/City Hall micro-markets reach unprecedented levels of 99%, 97.5% and 99.6% respectively (source: Colliers International).

New supply well taken up. The strength of the leasing market can be seen from healthy take ups at Marina Bay Financial Centre (MBFC). Phase 1 with 1.6m sf and Phase 2 with 1.3m sf of office space will be completed in 2010 and 2012. Both phases are more than 50% pre-committed by major financial institutions. Standard Chartered has signed a 12-year lease for 508,300sf at MBFC Phase 1 with option to extend for another eight years. DBS Bank has signed a 12-year lease for 700,000sf occupying 22 floors at MBFC Phase 2.

Capital values supported by keen foreign interest. Investors’ interest in office properties remains strong, especially from foreign funds. Foreign investors accounted for the majority of large transactions in 2H 2007. Capital value for prime office space in Raffles Place is estimated at 3,100psf, an increase of 6.9% qoq and 106.7% yoy (source: CB Richard Ellis).

Office REITs – OVER WEIGHT. We favour the office market due to positive rental reversion and limited supply coming on stream in 2008 and 2009.

CapitaCommercial Trust (BUY/S$1.90/Target: S$2.45). CCT is well positioned to benefit from positive rental reversion as 56.9% of its leases for office space are up for renewal in 2008 and 2009, when supply coming on stream is fairly limited. It will redevelop Market Street Car Park into a premium Grade A office tower with estimated net lettable area of 680,000sf. CCT’s gearing is low at 24% in Dec 07 and has secured funding for refinancing of short-term borrowings and the acquisition of Wilkie Edge.

K-REIT Asia (BUY/S$1.47/Target: S$1.96). K-REIT Asia has proposed a renounceable rights issue of up to 420m units priced at a discount of up to 20% to the prevailing market price. Keppel Corporation and sponsor Keppel Land own 72.7% of K-REIT in aggregate and have given irrevocable undertaking to take up their respective allocations of rights units. We believe the stock is oversold. Our target price for K-REIT is S$1.96 assuming 372.1m new units were issued at S$1.20 each in a 3-for-2 rights issue.

Suntec REIT (BUY/S$1.40/Target: S$2.10). Suntec REIT will benefit from improved connectivity to Suntec City due to the Esplanade and Promenade MRT stations when the new Circle line is ready in 2010. It has acquired 14,677sf of state land for construction of new extension at Park Mall, which increases gross floor area by 67,810sf or 17.7% to 451,727sf.

Suntec REIT has issued 5-year S$250m convertible bonds, convertible into cash or new units. The conversion price is initially S$1.968/unit. The bonds bear interest rate of 3.25% and yield to maturity of 4.25%. Suntec REIT intends to settle the bonds in cash on conversion to minimise dilution. We have factored in the higher cost of debt in our forecast and lowered our target price from S$2.18 to S$2.10.