Positive rental reversions continue

What has changed?

• K-REIT Asia (KREIT) announced 2Q FY09 results on 20 July. Distribution per unit (DPU) of 2.64¢ was 21.8% above our forecast.

Impact

• KREIT’s net-property income, up 13.8% QoQ, was 27.7% above our forecast, helped by an easing of property taxes and other expenses.

• Top-line growth, up 3.9% QoQ, was also impressive, considering that occupancy for KREIT’s properties (excluding its one-third stake in One Raffles Quay, which was fully occupied) deteriorated slightly to 92%, from 93.4% at the end of March. Even though spot rents continued to fall, KREIT’s lease renewals were still accretive because passing rents increased QoQ for all properties and expanded overall to S$7.11 per square foot/month (from S$6.71 per square foot/month for 1Q FY09).

Valuation

• We have raised our target price to S$1.23 from S$1.03, based on our RNG valuation method, after lowering our effective cap-rate assumption to 5.75% from 6.5%. As with all office S-REITs, we use 2008 core-operating distribution as the basis for our valuation since it captures what we believe is a reasonable mid-cycle passing rent (about S$5.64 per square foot/month for its investment properties).

Catalysts and action

• We have revised up our DPU forecasts by 14.5% for FY09, 6.1% for FY10, and 6.2% for FY11 on higher rental renewal assumptions. We have also lowered our operating expense assumptions and assume that the manager can maintain overall occupancy at 92% for the rest of 2009 before the occupancy falls to an estimated 87% for 2010 due to the addition of new office supply.

• We maintain our 2 (Outperform) rating for KREIT because we believe it is one of the few S-REITs that offer value. Our target-price is based on 0.55x on our June 2009 NAV. Even though the manager did not revalue the properties, we believe the debt-to-asset ratio of 27.8% is highly defensive. How attractive KREIT remains will depend on the results of the other S-REITs, in our view.

2Q09 ahead, but negative rent reversions loom

Event

Yield provides support

• Slightly above expectation
• Positive reversion more than offset higher vacancy
• Outlook stabilizing, visibility remains poor
• Raising forecast, maintain Hold with TP $0.95

Results ahead of estimates. Kreit reported an 18% yoy rise (+4% qoq) in topline to $15.4m. NPI grew 34% yoy and 14% qoq to $12.3m while distribution income improved 23% yoy to $17.5m. DPU of 2.64cts works out to an annualized yield of 10%. No revaluation exercise was carried out in 1H09.

Higher rentals filled vacancy slack. The modest sequential rise in topline was the result of positive rental reversions being offset by higher vacancy level of 94.9% (-0.9% pt qoq). Average portfolio rents were $8.13psf vs $7.37psf a year ago. The higher jump in NPI was due to the impact of lower property tax, reduced marketing and utilities costs. Outlook for the office rental market has stabilized, however, visibility remains poor with demand remaining subdued this year. With asking rents ranging between $7-9psf (excl ORQ), we expect negative rental reversion to kick in next year. Kreit has a remaining 8% and 26% of NLA to be renewed/reviewed in 2H09 and 2010 respectively.

Valuation undemanding but lacks near term catalyst. At 0.46x P/bk NAV and implied office values of $995psf, Kreit’s valuation is undemanding. Portfolio resilience through its long weighted lease to expiry of 5.4 yrs provides stability in income base. However, we are hard put to find re-rating catalysts in the near term. We have raised FY09 and FY10 DPU to 9.4cts and 9.1cts respectively to reflect a slightly better than projected occupancy level vs our earlier assumption of 90%. This translates to yields of 10-9%. Maintain Hold with TP of $0.95.

K-Reit Asia’s Q2 distributable income rises 23%

OFFICE trust K-Reit Asia yesterday said that distributable income for the second quarter ended June 30 rose 23.4 per cent to $17.5 million from $14.2 million a year ago on the back of higher rental rates for new and renewed leases.

Distribution per unit (DPU) rose to 2.64 cents from 2.18 cents.

The trust, which is a unit of Keppel Land, also reported a 34.2 per cent rise in net property income to $12.3 million, from Q2 2008’s $9.2 million.

K-Reit’s portfolio – which includes Bugis Junction Towers and a one-third stake in One Raffles Quay – attained 94.9 per cent committed occupancy by the end of June. This is a drop from the 99 per cent occupancy the trust reported at the end of 2008. But income went up even as occupancy dipped slightly as rents climbed. The portfolio’s average gross rental rate was $8.13 per square foot in June this year as compared with $7.37 psf in June 2008.

For the quarter, the all-in interest rate was 4.25 per cent, as compared with 2.64 per cent for Q2 2008. The aggregate leverage remained the same at 27.6 per cent on June 30 and March 31 this year, and the weighted average term to expiry of debt was reduced from 2.0 years in March to 1.8 years in June.

K-Reit said that the pace of decline for office rents eased in Q2 and the office leasing market is more active. However, it expects demand for office space to remain subdued in 2009. But despite this, K-Reit ‘is well positioned with its high-quality asset portfolio, strong tenancy profile and diverse tenant business mix’, the trust said.

Based on committed leases at the end of June, K-Reit’s gross rental income for FY2009 already exceeds that for FY2008, the trust pointed out in a statement. The weighted average lease term to expiry for the trust’s portfolio is 5.4 years while that of its top 10 tenants is 7.1 years. This provides stable rental income, the trust said.

Going forward, K-Reit’s manager will continue to place emphasis on tenant retention and seek to improve operational and cost efficiencies. K-Reit will also make selective asset acquisitions should opportunities arise, it said.

K-Reit gained 2 cents, or 1.9 per cent, to close at $1.05 yesterday.

All eyes on vacancies

Rating downgraded to 2 from 1