Digesting OFC

With the beginning of job cuts and upcoming office supply, we think it’s too early to turn positive on K-REIT. Though nowhere near breaching loan covenants, risks of cash calls are fairly high, given its high aggregate leverage.

4Q11/FY11 reported DPU is broadly in line with consensus and our estimates, at 19/95% of our FY11. We fine-tune our DPU estimates but keep our DDM-based TP (disc rate: 9.6%). Maintain Underperform.

Office headwinds

4Q11 DPU was down 18% yoy and 29% qoq as contributions from Ocean Financial Centre (OFC) were overwhelmed by higher interest costs and an enlarged unit base after its rights issue. The dip should be temporary given only two weeks of contribution from OFC vs. full unit-base expansion. While a new tenant has been secured for OFC (taking occupancy to 85% from 80%) and remaining lease expiries are limited in FY12, occupancy was flat at Prudential Tower (94%) and 77 King Street (88%) from 3Q.

Delayed impact

We reckon that the impact of an office slowdown could have been delayed, as businesses slow towards year-end and with job cuts only starting to kick in. Management has yet to note major signs of tenant distress, with asking rents still quite stable. So far, one tenant at MBFC 1 has raised the topic of subletting though it has yet to go ahead with the proposal.

Aggregate leverage at 42%

While management is comfortable with current leverage, we remain concerned about the potential of office asset devaluations. K-REIT’s assets are pegged to levels in Oct 11 when OFC was being acquired, implying downside risks. We foresee a cash call for Marina Bay Financial Centre Phase 2 though this could be pushed back on concerns of corporate governance after the OFC acquisition.

K-Reit post-rights Q4 DPU falls

K-REIT Asia yesterday posted improved results for the fourth quarter ended Dec 31, 2011, on the back of higher contributions from associates and higher interest income. Property income for the office Reit was $22.6 million in Q4, up $1.3 million or 5.9 per cent from a year earlier.

This was mainly due to higher property income from its Australian properties, Bugis Junction Towers and contributions from Ocean Financial Centre (OFC). However, this was slightly offset by a $6 million loss in property income resulting from the sale of Keppel Towers and GE Tower. Net property income rose 1.4 per cent over the same period to $17.8 million.

Distributable income to unitholders for the period jumped 54 per cent year on year to $35.7 million from $23.2 million a year earlier. This translates to a distribution per unit (DPU) of 1.4 cents for Q4, based on an enlarged post-rights share base. DPU in Q4 2010 was 1.71 cents.

For the full year ended Dec 31, K-Reit’s net property income was $61.7 million, down 8.4 per cent from the previous year.

Share of results of associates, however, almost quadrupled to $37.4 million from $9.7 million a year ago. Distributable income also rose 32 per cent to $113 million, representing a DPU of 7.08 cents for the full year ended Dec 31, up 11.1 per cent year on year.

Based on K-Reit’s closing price of $0.83 as at Dec 30, the last trading day of 2011, the distribution yield for the year was 8.5 per cent.

The counter ended trading yesterday at $0.895, up 2.3 per cent or two cents.

K-Reit’s Singapore portfolio occupancy of 93.9 per cent outperformed that of the core central business district of 91.2 per cent.

The Reit has about 2.2 per cent of net lettable area due for rent review and renewal in 2012. However, it has given its assurance that that with a portfolio-weighted, average lease expiry of 6.7 years and healthy capital levels, it is in ‘good stead’ to weather the economic slowdown in 2012.

Commenting on the uptake of one of the Reit’s latest assets, OFC, Ng Hsueh Ling, the CEO of K-Reit Asia Management, said she hoped to achieve 100 per cent occupancy in the building by June next year. Currently, the asset’s committed occupancy is about 85 per cent.

K-Reit’s aggregate leverage at Dec 31 was 41.6 per cent based on borrowings of about $2.5 billion.

Looking ahead, Ms Ng said she would be ‘quite comfortable’ with gearing in the range of 40 to 41 per cent, including debt at the associate level.

K-Reit’s Aussie tower gets anchor tenant

K-Reit Asia’s 50 per cent-owned 8 Chifley Square – a premium office tower that is under construction in Sydney – has found its first anchor tenant for 40 per cent of its net lettable area.

The office, whose development is due for completion in the third quarter of 2013, is located in the heart of Sydney’s central business district, at the junction of Hunter Street and Elizabeth Street. The other 50 per cent owner is Mirvac Property Trust, a member of the Mirvac Group.

The building will have an estimated 205,700 square feet of net lettable area.

The tenant, Australian law firm Corrs Chamber Westgarth, has pre-committed to about 87,000 square feet of space for a 12-year term, over levels nine to 18 of the 30-storey building.

Ng Hsueh Ling, chief executive of K-Reit Asia Management, said: ‘The strong pre-commitment level affirms our positive sentiments on the Australian office market. We anticipate healthy demand for the remaining space.’

The building features a ‘village’ concept where tenants can lease one to three floors of contiguous office spaces which are interconnected and improve interactivity between its occupants. It will also have 36 car park lots and 156 bicycle lots across two basement levels.

K-Reit Asia, which is sponsored by Keppel Land Limited, has an asset size of about $6 billion, comprising eight commercial properties.

In Australia, K-Reit Asia also owns a 50 per cent interest in 275 George Street in Brisbane, and an office tower at 77 King Street in Sydney.

In Singapore, K-Reit Asia owns Bugis Junction Towers, a one-third interest in Marina Bay Financial Centre Towers 1 & 2 and Marina Bay Link Mall, an 87.5 per cent interest in Ocean Financial Centre, a one-third interest in One Raffles Quay and 92.8 per cent of the strata area in Prudential Tower.

K-Reit voting prompted query from MAS

Show-of-hands vote to avoid minority investors’ ire: CEO

K-Reit Asia had conducted the voting over the purchase of Keppel Land’s entire 87.5 per cent stake in Ocean Financial Centre via a show of hands to avoid the ire of minority investors, chief executive Ng Hsueh Ling told BT yesterday.

This has prompted a query from the Monetary Authority of Singapore (MAS) – which regulates property trusts – on the proceedings of the unitholders’ meeting, she revealed, though no subsequent questions have been posed since then.

About a year ago, K-Reit had gone through a similar voting process to gain unitholders’ approval for an asset swap with its sponsor Keppel Land.

This had Keppel Land selling its one-third stake in Phase One of Marina Bay Financial Centre to K-Reit, while K-Reit selling Keppel Towers and the adjacent GE Tower in Tanjong Pagar to Keppel Land.

But during last year’s meeting, minority unitholders were upset with the decision to have voting done by poll, arguing that this voting method would silence the unitholders since institutional investors often hold a larger block of units.

With poll voting, each share translates to one vote, whereas under a show-of-hands system, each person gets a single vote, regardless of the number of shares he holds.

This year, about 350 unitholders present at the extraordinary general meeting were given the option to vote by poll or by show of hands.

Minority unitholders can call for a voting by poll so long as this request is supported by unitholders representing at least 10 per cent of the units held by those present – as stipulated in the Reit’s trust deed.

But the poll request, led by an institutional unitholder and supported by a few retail unitholders, did not meet the requirement.

To compound matters, K-Reit’s chairman Tsui Kai Chong told unitholders there were proxy votes representing 46 million units that favoured the deal, before calling for unitholders who wanted a poll to register with the company.

The 46 million units included votes from institutional investors whom K-Reit had met to discuss the deal during its roadshow, Ms Ng noted.

‘Even if every single person present at the meeting had voted against, what the chairman had in terms of the positive proxies would have (seen the deal) more than comfortably passed through the poll,’ she said.

‘Since people who called for the poll didn’t meet the requirements, we thought, ‘why should we go against the trust deed and have our discretion?’ People might say, why did you use your discretion?

‘I guess we could never win it,’ she added.

The deal also won overwhelming support via a show of hands, with Ms Ng noting that the hands in favour were ‘too many to count’. By Ms Ng’s account, there were just six to seven hands raised to show disapproval of the deal.

Voting through a show of hands is a practice that the Code of Corporate Governance no longer accepts as sound governance.

This was reflected in the recent review of the Code, though the findings were announced two weeks after the deal was approved.

K-Reit nudged parent to get hands on OFC

CEO feels it’s still a good deal and explains why

It was K-Reit Asia that approached its sponsor Keppel Land to snap up Ocean Financial Centre (OFC). This was to have a say in rental negotiations now underway, get tax exemption and to lower the average age of its property portfolio.

The dynamics behind the deal were revealed by K-Reit’s chief executive officer Ng Hsueh Ling yesterday, even as the real estate investment trust faces criticism that the deal is too expensive at a time when the office market may soften.

Ms Ng also rejected suggestions that Keppel Land got the sweeter deal. She noted that the $1.57 billion that K-Reit paid for Keppel Land’s 87.5 per cent stake in OFC is still well short of the peak.

‘If you look at the historic peak of the market, the highest transaction was about $3,120 (per square foot) for a plot of land along Robinson Road. We figured that $2,380 psf is very far from the peak, and it’s one of the best buildings in Singapore,’ said Ms Ng.

‘How do we know the bottom? And to go out and get money in a bad market, people will say ‘no’.’

Ms Ng added that Keppel was not urgently looking to offload the property.

‘They are in no hurry to sell,’ she said. ‘A lot of people have asked me who started the negotiations first. I wanted to buy OFC because I don’t want it to be fully leased.’

Some 20 per cent of the space in OFC is having its rental negotiated. She wanted to fill this space with tenants who wanted long-term leases, took up large amounts of space, and had a good credit backing.

‘I didn’t want Keppel to fill up the extra 20 per cent because Keppel is a developer. I want to fill up with Reit-like tenants,’ she said.

‘I can also wait for Keppel to fill up the space but you can’t control the tenants and you will have to pay for a fully valued asset. If the market goes down, sorry, you would have paid at that price.’

She remains very confident that the space will be taken up by such tenants. And despite the grim economic outlook, customers have not asked for cuts in the rent rates, with Ms Ng saying these are large firms and long-term players.

Touching on the 17-for-20 rights issue to be used to foot the bill – a move that would be dilutive for existing shareholders – Ms Ng said cash calls are inevitable in order to grow the portfolio size, especially since purchases in the office space are big.

‘Now that K-Reit is large in size, the chances of going out to do another rights issue will be much lesser than when it was smaller.’

Early this year, the Reit asked the Inland Revenue Authority of Singapore (IRAS) whether all income coming from OFC could be exempted from a 17 per cent tax payment if the corporate ownership structure was changed to a limited liability partnership from a private limited structure, under which a company has to pay that amount of tax.

The property trust was told by IRAS around June that this would be possible – making it the first time an office building here has been allowed such a tax exemption under this structure. This prompted the Reit to begin serious negotiations, Ms Ng said.

With the purchase of OFC – which will not require K-Reit to spend money on asset enhancement initiatives – the average age of the properties in the portfolio will be lowered to 4.4 years, she added. ‘No other Reit has that kind of age. It doesn’t mean that being young alone is good. You must be young and in the right location,’ she said, though she had no figures on the industry average.

As for the compensation of Reit managers, Ms Ng argued that her remuneration is based on the performance of the Reit, noting that she needs to meet targets set for the managers.

Acquisition fees paid to the manager are in the form of units that can be sold only after a year, which means that the manager has to watch the units’ market performance.

Ms Ng also defended the sponsor model that Singapore Reits operate under, noting that a sponsor provides a supply of assets to refresh the Reit’s portfolio.

K-Reit noted that sponsors are also aligned with the Reit as cornerstone investors, and that working under this model gives Reits access to bank funding.