Category: KepREIT
K-REIT – CIMB
Still unattractive despite rental revisions
• Maintain Underperform. With positive pre-leasing momentum and rental growth, we upgrade our rental assumptions for One Raffles Quay (ORQ) and Marina Bay Financial Centre (MBFC). We raise our FY11-12 DPU estimates by 3-18% after factoring in higher rental growth and lease review assumptions. Our DDM (discount rate 7.2%) target price accordingly climbs to S$1.43 (from S$1.26). Also, should Keppel Land inject its 87.5% stake in Ocean Financial Centre (OFC) into K-REIT, any accretion would depend on asset price and source of funding. Maintain Underperform with yields remaining unattractive after our rental revisions. De-rating catalysts include lower-than-expected rental reversions, in our view.
• Rental revisions for ORQ and MBFC. With positive news flow on rental movements and strong pre-leasing momentum, we raise our rental assumptions for ORQ and MBFC and update lease review assumptions for ORQ. We now expect 30% of the leases to be renewed each year in FY11-12 for ORQ, which should mitigate the DPU fall expected when ORQ income support expires in FY12.
• Accretion from OFC acquisition? With the impending completion of the MBFC acquisition, we ran a scenario analysis to determine the impact of injecting Keppel Land’s 87.5% stake in OFC into K-REIT on K-REIT’s FY12 DPU. In view of KREIT’s limited debt headroom, any transaction will likely entail equity fund-raising. Whether the deal is accretive will depend on the actual price and source of funding.
REITs – CIMB
Still interesting but could grow more risky
• Downgrade to Neutral from Overweight. The SREIT sector met our Overweight expectations since our upgrade in May. While valuations are not demanding and sustained low interest rates remain favourable for REITs, we downgrade the sector on increased risks expected from non-accretive potential acquisitions and possible cash calls as well as limited upside for the large caps. No changes to our earnings estimates or individual stock ratings. Our top pick is still Cache Logistics for its attractive 8.3% yields and undemanding valuations at book value. Among large-cap REITs, CCT as the cheapest is our preferred liquid REIT, provided it is able to make accretive acquisitions. Our top short is CMT, which has limited growth catalysts for the next two years in our view, significant capex needs and possibly increased interest costs if holders of its convertible bonds exercise their put options next year.
• REIT sector trading at book levels. The REIT sector has made a good recovery since its trough and now trades at book levels, above the last two years’ average P/BV of 0.8x. The largest-cap REITs, CMT and AREIT, trade at about 30% premiums to the sector, which is their historical mean premium. A review of the debt profiles of the 14 large- and mid-cap REITs shows healthy asset leverage at 31.6%, and interest cover ratio at 5x.
• Sponsor injections likely to take centre stage in 2011. We anticipate more sponsor injections in 2011 which could include Ion Orchard Shopping Mall (into CMT), Ocean Financial Centre (into KREIT), and Pantai Hospitals in Malaysia (into PLife REIT).
• We expect risk levels to increase as: 1) asset prices rise under intensifying competition from funds and other investors; 2) assets with limited operational histories are unlikely to be accretive in the short term without income support from vendors; 3) a lack of accretive assets locally could drive REITs to acquire more overseas assets, increasing forex uncertainties and tax leakages; 4) the possibility of more cash calls particularly for mega-acquisitions as most REIT managers are unlikely to go for long-term gearing ratios beyond 45%; and 5) an increasing preference for private placements over rights issuances in recent equity fundraising points to a less equitable position for minority REIT investors.
K-REIT – BT
K-Reit DPU up 4% after asset swap
Unit-holders recommended to vote in favour of planned transactions
A PROPOSED asset swap between Keppel Land and its unit K-Reit Asia would increase the latter’s distribution per unit (DPU) by 4 per cent without the need for equity raising, according to a circular that K-Reit sent to its unit-holders yesterday.
K-Reit’s manager said that unit-holders would enjoy a higher DPU of 6.68 cents for the forecast year of 2011, up from 6.42 cents upon the completion of the transactions.
Last month, the two companies announced a deal under which K-Reit would acquire a one-third interest in Marina Bay Financial Centre (MBFC) Towers 1 & 2 and Marina Bay Link Mall from Keppel Land, and at the same time would dispose of Keppel Towers and GE Tower to its sponsor.
Some analysts have questioned if the deal is as beneficial to both parties as claimed. They asked if the MBFC purchase would be yield-accretive to K-Reit and whether Keppel Towers and GE Tower could have fetched a higher price in competitive bidding. They also pointed out that K-Reit would have to increase its borrowings to fund the purchase of MBFC. Yesterday’s circular answered some of the questions raised.
The deal would be yield-accretive, but only if the interest rates for the new borrowings remain between 2.5 per cent and 3.25 per cent per annum, the Reit’s manager said. A 50-basis point increase in the base case borrowing costs would reduce the DPU to 6.31 cents. Fluctuations in interest rates would have the impact on the DPU of K-Reit following the transactions.
But based on the current low interest rate environment, K-Reit’s move to take on new debt would reduce its average borrowing cost to 3.05 per cent, from 3.4 per cent as at Sept 30, 2010. The trust’s weighted average debt maturity would also increase to 4.1 years, from 1.4 years.
As for the valuations of the transactions, K-Reit’s independent financial adviser PricewaterhouseCoopers Corporate Finance (PwCCF) has said that it considers them fair. In particular, the sale price of $573 million for Keppel Towers and GE Tower is higher than the average of the open market values of the two buildings as appraised by the independent valuers – Savills and Knight Frank – on the ‘highest and best use basis’, it said.
Based on that, and having considered the rationale for the transactions, PwCCF advised that the independent directors recommend that unit-holders vote in favour of the transactions, which will be proposed at an extraordinary general meeting on Dec 8. Similarly, the independent directors of Keppel Land have also recommended that minority shareholders vote in favour of the transactions.
Since the proposed deal was announced, Keppel Land’s share price has shot up 23 per cent, outperforming the FTSE ST Real Estate Holding and Development Index by a whopping 20 percentage points. K-Reit, meanwhile, has edged up a mere 1.5 per cent. But still, it managed to pip the Reit Index by half a percentage point. 
Office REITs – OCBC
The Going gets Exciting as Competition Heats Up
Office rents strengthening. Office rents continued to strengthen in 3Q10 after turning around in the 2Q10. According to CRBE, Prime-Office rents averaged $7.40 psf/month, up from $6.90 psf/month in the previous quarter; Grade-A rents also rose 6.5% QoQ to average $9.00 psf/month. Major leasing deals were principally concentrated on new Grade-A developments. Financial institutions, legal firms, insurance and professional services remained the major source of occupier demand. Investment activity in the office market also warmed up. Improving visibility of the office recovery and rental cycle stand to benefit the four local Office REITs, namely Suntec REIT [BUY, FV: S$1.64], CapitaCommercial Trust (CMT) [HOLD, FV: S$1.52], K-REIT Asia [NOT RATED] and Frasers Commercial Trust (FCOT) [NOT RATED].
MBFC – the place to be at. K-REIT Asia and Suntec REIT intend to each acquire a one-third interest in Marina Bay Financial Centre (MBFC) Phase-One, constituting Towers 1 and 2, Marina Bay Link Mall and slightly less than 700 carpark lots. Excluding rental support, both are paying about $2400 psf for Singapore’s latest iconic development. MBFC is deemed a strategic acquisition on the back government’s commitment to pump more than S$1b into infrastructure works to support Marina Bay’s growth over the next 10-15 years and increasingly greater demand for Grade-A office space in Singapore. Noticeably, the acquisitions, if successful, will also propel Suntec’s investment properties to ~$5.8b, surpassing CCT’s S$5.2b (as reported in 3QFY10 results). K-REIT Asia’s investment properties, accounting for the divestment of both Keppel and GE Towers, will also levitate above S$2b from the current $1.38b. We view these two enlarged REITs as not only upping the stakes but also exerting pressure on CCT and FCOT, who have yet to announce any local acquisitions YTD.
Valuation. Office-REITs trade at an average forward yield of 5.6% and an average-price-to-book of 0.80x, which compares favourably to the broader S-REIT sector of 0.952x. We have a BUY rating on Suntec due to its wider exposure to the revitalizing Marina Bay area and improved quality of its office space (more Grade-A exposure) and we like K-REIT for similar reasons. We also noted that CCT is sitting on a cash pile of some S$731m following the sales of Robinson-Point and StarHub-Centre and certainly has the financial muscle for new acquisitions. In addition, we feel that market attitude towards Office REITs is turning due to increased leasing activity, better employment outlook and proactive lease management tactics taken by office landlords. We remain upbeat on the office sector recovery; and now have an OVERWEIGHT rating for the Office-REITs subsector.
K-REIT – Lim and Tan
• K-Reit expects its DPU for 2011 to be 10.2% higher at 6.68 cents as a result of the recent transactions:
a. acquisition of 77 King Street property in Sydney for A$120 mln / S$145 mln and announced in July;
b. acquisition of one-third stake in Marina Bay Financial Centre‘s Towers ! & 2 for $1,426.8 mln;
c. disposal of GE Towers and Keppel Towers for $573 mln.
• K-Reit will borrow a net S$821 mln for the latest transactions, and will not issue new units.
• At $1.37, prospective yield is 4.9%.
• K-Reit merits an upgrade to BUY with the removal of the “uncertainty”, whether the Singapore transactions would be yield accretive.
(For Q3 ended Sept ’10, K-Reit’s Distributable Income rose 26% to $22.7 mln reflecting the additional 29% interest in Prudential Tower as well as the 50% stake in 275 George Street, Australia. DPU for the first 9 months came to 4.65 cents or 6.22 cents annualized.)