KREIT – DBS

Pricing in cloudy sector outlook

Story: K-REIT reported a 34% y-o-y jump in 3Q08 revenue to S$13.9m, led by higher rental rates and occupancies. However, NPI grew by a lower 27% to S$9.5m due to an increase in expense ratio to 31.2% arising from higher property taxes. Distributable income grew 35% to S$15.2m, translating into 2.34cts DPU.

Point: The better performance was the result of organic growth from positive rental reversion, as well as inclusion of contributions from ORQ. Its portfolio occupancy remained strong at 99.4%, while office rents were stable in the quarter. An estimated 1.5% of portfolio NLA was renewed during the quarter, and the lag effect between new and previous rates boosted average rents by 0.8% qo-q to S$7.43psf/mth. Looking ahead, anticipated slower economic growth and the worsening global financial crisis will dampen demand for office space and rental growth.

Coupled with an increasing supply of new office space coming onstream over the next two years, rental rates and capital values are likely to soften. This will likely moderate DPU growth going forward. Meanwhile, refinancing concerns have abated after K-REIT managed to secure a revolving loan facility that extended its loan maturity profile to 1H2011.

Relevance: Like other office REITs, K-REIT’s share price tumbled amid concerns over the office sector. Current valuations are inexpensive at 10.6% FY09F DPU yield and implied asset value of S$870psf vs its Dec 07 valuation of S$1,707psf. However, it lacks a near-term catalyst given anticipated negative newsflow on the office sector. Our RNAV of $1.16 has factored in a 35% decline in office rents over this cycle. Maintain Hold recommendation with a price target of S$0.93, based on 20% discount to RNAV.