Office REITs – OCBC

Comparing the four office REITs

Vulnerable to negative rent reversions in FY10-11. Many of the leases secured on high rents during the hot 2007-2008 period will be expiring in 2010 and 2011. It is very likely that these leases will be renewed or replaced at much lower levels. This, in turn, will have an effect on revenue and distributable income, in our view. Among the four office REITs we discuss here, Frasers Commercial Trust [FCOT, NOT RATED] has the lowest percentage of NLA expiring (16.9%) in FY10 and FY11. K-REIT Asia [K-REIT, NR] follows with 32.2% of its NLA expiring in FY10-11. CapitaCommercial Trust (CCT) and Suntec REIT (Suntec) will see the most expiring office leases: 52.3% of CCT's gross rental income derived from office space will be up for renewal in FY10-11. Meanwhile, leases on 41.8% of Suntec's office NLA expire in FY10-11. While REITs may be hit by the appetite for newer buildings, we believe tenants will still favor quality assets such as Six Battery Road.

Expect significant re-financing activity. We estimate that S$2.4b of office REIT loans mature in both 2011 and 2012. The bulk of the maturities are for Suntec and CCT loans. We believe the REITs will tap on secured loan facilities, convertible bond issues and medium-term note programs to meet their re-financing needs. Some of the REITs could potentially test the CMBS market but in small amounts. We expect the REITs to start the re-financing process early to take advantage of the easing credit market, the low interest rate environment, and to assuage any remnant investor jitters. Quality sponsors and quality assets will continue to be crucial to securing competitive pricing.

Valuation. Office REITs trade at an average forward yield of 6.9%. They trade at an average price-to-book of 0.71x, which compares favorably to the broader S-REIT sector. We have BUY ratings on both Suntec and CCT as we feel their current valuations more than reflect the challenges facing the office sector. Suntec is one of our top picks for the broader S-REIT sector due to its exposure to the revitalizing Marina Bay area and its oft-forgotten retail portfolio (two Circle Line MRT stations open at Suntec City next month). In addition, we feel that market attitudes towards office REITs may start turning due to increased leasing activity and the supply management tactics taken by office landlords including CCT. Investors who want a purer exposure to the office sector may prefer CCT to Suntec.