Asset enhancement at 6 Battery Road

Asset enhancement at 6 Battery Road. Last week, CapitaCommercial Trust (CCT) unveiled its asset enhancement initiative (AEI) at 6 Battery Road (6BR). The upgrade will focus on improving the building’s energy efficiency, environmental sustainability, as well as the facilities in the building. The AEI will commence in Oct 2010 and carried out in phases until 2013 in order to minimize the inconvenience to its tenants. Upgrading of common facilities ground floor lift lobby, turnstiles and reception area will start first while the enhancement of office space will be carried out upon the lease expiry of tenants. The building will remain tenanted during the upgrading period. Estimated capex for the AEI is ~S$92m and the cost is equivalent to 8% of the building’s valuation at the end of Dec 2009.

Positioning for long term growth. With Nomura likely to move out of 6BR to Marina Bay Financial Centre and Standard Chartered downsizing its office space in 6BR by 70,000 sq ft when their leases expire, near term outlook for CCT remains challenging. Nevertheless, we view this AEI positively. We believe that the completion of the upgrading works will place 6BR in a better position to compete with the newer office buildings and thus leading to higher rental rates. The AEI is expected to complete in 2013 and with no new supply of new office space in that year, we believe that CCT will have better bargaining power to negotiate for higher rental rates from its tenants.

Maintain BUY. According to CCT, the AEI is expected to generate incremental gross revenue of S$9.2m pa and incremental net property income (NPI) of S$7.4m pa. Management estimates that 20% of the incremental NPI (~S$1.5m) will come from cost savings due to reduction in energy consumption. The other 80% of the increment NPI (S$5.9m) will come from higher rental rate that the building is expected to achieve post-AEI. However, we think that it is too early to make any adjustments to our rental assumptions from 2013 onwards as there is still a lack of clarity on the recovery in office rents, which will depend on the take-up rate of the upcoming supply of office spaces in 2010-2012 and the sustainability of the economic growth. As such, we leave our estimates unchanged. Our fair value also remains at S$1.26. With a total return of 16.4%, we reiterate our BUY rating on CCT.

Enhancing 6 Battery Rd

• 6 Battery Rd AEI could yield additional $7.4m NPI

• Small but positive move to maximize returns

• Maintain Hold with TP $1.24

CCT to enhance 6 Battery Rd. CCT has proposed to embark on asset enhancements for 6 Battery Rd, including upgrading of interior specifications such as facelift of ground lift lobby and reception areas, improving existing lifts, renewing restroom facilities, increasing ceiling height to 2.8m, enhancing building management system and putting in a Next Generation National Broadband Network. To be completed in phases over Oct 2010-2015, the $92m initiative will be funded internally (current gearing 33.8%) and yield a ROI of 8.1% or $7.4m additional NPI.

Small but positive move to maximize return. While the impact is relatively small, we see this move to tap low hanging fruits from its existing portfolio as positive and in line with its portfolio reconstitution strategy. With the bottoming out of the office rental market, this exercise is also timely. 6 Battery Rd is well located in the prime Raffles Place area with direct access to MRT nodes and has a long remaining underlying land lease of 815 years. The upgrading works will be done in tandem with tenant lease expiries to minimize downtime. This would coincide with major tenant Standard Chartered’s (SC) plan to give up 70k sf of space (14% of building, 2% of portfolio space) upon expiry in 2011. Potential candidates to take up the slack have already been identified. SC will retain c120ksf of NLA in the building.

Slight uplift in TP to $1.24. We have maintained FY10 and FY11 DPU estimates of 7cts and 6.7cts respectively, as the expected vacancy of 5% during the AEI period is within expectations. We expect the impact of additional income to be felt post FY13, which will raise DCF by 1ct to $1.24. CCT is currently trading at 6.4-6% FY10-11 yield and 0.8x P/BV. Other share price catalysts such as plans to redevelop Starhub Centre are still awaiting approvals and acquisitions are unlikely to materialize any time soon. As such, we maintain Hold.

Revamping 6 Battery Road

S$92m to revamp crown jewel

Maintain Outperform. The manager of CCCT announced last Friday that it will be spending S$92m on the asset enhancement of its crown jewel, 6 Battery Road. Separately, Standard Chartered will be giving up 70,000sf of its space in 2011. We believe the asset enhancement is a defensive move to position CCT’s crown jewel positively against new buildings which will be completed over the next few years. We also believe management will be able to find replacement tenants for Standard Chartered’s space in view of improving indicators for office space. We factor in higher capex costs, but not potentially higher rents as these would only come through after 2015. We also maintain our renewal rent estimates for 6 Battery Road as a 35% decline in FY11 rents had been incorporated earlier. We make no material change to our DPU estimates and target price of S$1.37, still based on DDM valuation (discount rate 7.8%). CCT offers a dividend yield of 7.1% and remains the cheapest large-cap SREIT (0.8x P/BV). We see stock catalysts from improving office demand indicators.

No change to net lettable area (NLA). The asset enhancement work will include a revamping of common areas (lobby, reception area, turnstiles), M&E upgrade of electrical power supplies, “green features” etc. and enhancement of office space (increasing ceiling heights, air-conditioning and sprinkler systems, lift lobbies and restroom finishing). There will be no change to net lettable area.

Completion expected in 2013. The work will be carried out from 3Q10 to 2013. However, the rectification of defects may stretch into 2015. To minimise disruptions to tenants, refurbishment of the interior of tenants’ space and restrooms will be carried out only during the interim period when new tenants fit out their space. Hence, we do not expect significant downtime. The estimated cost of S$92m will be spread over six years with chunkier payments in 2012 (S$30m) and 2013 (S$28m). The manager will be funding the capex with cash on hand.

Returns on investment (ROI) of 8.1% have been forecast on a stabilised basis by management. This translates into incremental net property income of S$7.4m. The manager expects 20% of this increment to come from cost savings from “green features” to be installed, and 80% from potentially higher rental reversions.

Key tenant, Standard Chartered, will give up 70,000sf of space by 2011. This represents 14% of the NLA at 6 Battery Road. Nonetheless, StanChart will retain 120,000sf of space in a separate lease which will expire only in 2020. Management is in talks with prospective tenants for the space which will be given up, both new and existing tenants who are looking to expand. We believe this is an opportune time for CCT to reduce its tenant-concentration risks by leasing out the space to more than one tenant.

Decline in renewal rents anticipated. From CCT’s 1Q10 results presentation, expiring leases in 6 Battery Road have a high average rent of S$15.93psf. We have assumed a 35% decline in renewal rents to S$10.35psf. We believe the prospect of leasing the space to more than one tenant is likely to limit any southward march in renewal rents.

Impact on CCT. In our view, the asset enhancement is a defensive and necessary move to position CCT’s crown jewel positively against new buildings which will be completed over the next few years. Furthermore, a lack of new supply in 2013 when the bulk of the refurbishment work will be completed should appeal to prospective tenants, since there will not be much competition. We are not overly concerned about Standard Chartered giving up its space in FY11 as we believe a revival in demand for office space is increasingly apparent (refer to our report “Four turning points in office rents” dated 20 May 10). We increase our capex assumptions to factor in the cost of the asset enhancement, but not any increased rents as these would only come through after 2015. There is no material change to our DPU forecasts and target price of S$1.37, still based on DDM valuation. CCT offers a dividend yield of 7.1% and remains the cheapest large-cap SREIT (0.8x P/BV). We see stock catalysts from improving office demand indicators.

Stanchart to lighten up, CCT gears up for $92m improvement

Bank gets ready to give up some space at Six Battery Road when lease expires next year

STANDARD Chartered Bank will be vacating about 70,000 sq ft at Six Battery Road when its lease at the building runs out next year. However, the bank will retain its remaining space of 129,000 sq ft in the building on which the lease expires in 2020. The latter space is understood to include the banking hall.

The building’s owner, CapitaCommercial Trust (CCT), has already identified prospective tenants to take up the space Stanchart will be vacating, and will take advantage of the transitional downtime in occupancy during the changeover of tenants to execute a $92 million asset enhancement at the building, which will be done in phases from October this year to 2013 to minimise inconvenience to tenants.

Earlier this week, Six Battery Road was awarded the Building and Construction Authority’s Green Mark Platinum award, the first time an operating office building here has won the highest Green Mark accolade. The award has been conferred for the proposed environmentally sustainable features CCT is implementing as part of the asset enhancement works for the 42-storey building. The Grade A office property contributed 22 per cent of CCT’s net property income in Q1 this year and ‘the asset enhancement ensures this robust income continues from this asset’, said Lynette Leong, CEO of CapitaCommercial Trust Management Ltd (CCTML).

‘We believe that market rents have reached a trough and we’re positioning this asset for the recovery of the market and we believe this is an opportune time to undertake asset enhancement so that it will continue to offer value-for-money office accommodation to tenants and sustain the building’s high occupancy and rental rates,’ she added.

CCTML is projecting a return on investment of 8.1 per cent on a stabilised basis for the $92 million asset enhancement works based on incremental annual net property income of $7.4 million once the works are completed. A fifth of the increase in income will arise from cost savings due to improved operating efficiency, while the other 80 per cent will be from higher rental projection. CCTML expects rents in the building to appreciate 10-15 per cent arising from superior specifications following the upgrade.

The increase in value of the building (net of the investment cost) is projected at about $82.9 million when the works are completed at end-2013. Six Battery Road was valued at $1.114 billion at end-2009. CCT will fund the asset enhancement from internal cash resources.

The upgrading works will kick off in October with the ground-floor lift lobby, turnstiles and reception area. Other planned works include redesigning of the chiller plant room system, incorporating a thermal energy storage system which will improve efficiency. The onyx wall in the main lobby will make way for the largest ‘green’ wall with living plants in a Singapore office building. This will help reduce indoor heat gain; the onyx will be reused in other parts of the lobby.

Rainwater will be harvested to irrigate the green wall. Exhaust air will be used to power a wind turbine that will in turn power the green wall’s irrigation pumps and lighting. To nudge tenants to use cleaner emission vehicles, CCT will set aside carpark lots for hybrid cars.

The canopy at the building’s entrance will be extended to cover the entire length of the drop-off area. For lettable areas, CCT will raise ceiling height from 2.6 metres to 2.8 metres and install variable air volume box and carbon dioxide sensors to improve indoor air quality. But these works will be done only for units for which leases have expired, before new tenants move in. The intention is to tie the upgrading of interior office spaces with the natural lease expiry profile. Six Battery Road received Temporary Occupation Permit in 1984 and was last retrofitted in 2000 at a cost of about $37 million.

The space to be vacated by Stanchart covers six to seven floors and CCTML’s plan is to upgrade the interiors of this space before leasing it out to other tenants.

The 70,000 sq ft that Stanchart will be giving up represents 14 per cent of the building’s net lettable area of 496,851 sq ft and 2 per cent of the 3.3 million sq ft total net lettable space in the trust’s portfolio.

Stanchart’s two main premises will be at Marina Bay Financial Centre (which it will start to move to by Q4 2010) and Changi Business Park (which it has already moved into). However, Stanchart will continue to house its flagship branch at Six Battery Road. Some consumer banking and group functions will also remain at this location, a Stanchart spokesman said.