K-REIT – UOBKH

Office Market: Not Out Of The Woods Yet

Semblance of stability. Management has started to see signs of stability in the office leasing market. The freefall in office rents has abated. Tenants who previously wanted to release space back to K-REIT Asia (K-REIT) have retracted their requests. Management has seen more enquiries since Jun 09. Some of these enquiries have translated into actual commitment in Sep 09. Tenants have also renewed for longer lease terms as they find current office rents attractive. The gap between office rents at Raffles Place and business parks outside the central business district (CBD) has also narrowed. Management expects average rents for Grade A offices to level out at about S$7psf.

A fragile office market. We are not as sanguine. We expect the office market to remain fragile due to the supply of 8.0m sf coming on stream from 2H09 to 2013, representing 11.0% of total office stock. A massive 2.8m sf and 2.6m sf will hit the market in 2010 and 2011 respectively, compared with the average annual take-up of 1.3m sf for the past 10 years. An estimated 87.2% of the known supply is concentrated within the CBD at Raffles Place, Marina Bay, Shenton Way and Tanjong Pagar. Take-up for office space was negative 570,000sf in 1H09. Take-up is likely to remain in negative territory in 2H09 as there is usually a time lag between retrenchment exercises and the release of excess office space. We continue to expect average rents for Grade A offices in Raffles Place to slide further to S$6.00psf by end-10, representing a two-third correction from the last peak of S$17.90psf pm recorded in 3Q08.

Maintain BUY. K-REIT is our only BUY call among office REITs. Our target price for K-REIT is S$1.32, based on a dividend discount model (required rate of return: 8.25%, growth: 2.5%).