SINGAPORE (Feb 18): The “less hawkish, more dovish” US Federal Reserve statements since December are likely to limit the upside for the US dollar. In a recent report, economists at Maybank-Kim Eng say: “The risks of further or aggressive tightening in Asean central banks’ monetary policy have diminished. Our baseline view is essentially a stable monetary policy stance in Malaysia, Singapore and the Philippines, and modest interest rate hikes in Indonesia and Thailand in 2019.

“The risk to our view is monetary policy easing and interest rate cuts instead, especially if our bet of a US-China trade deal out of the ongoing talks under the current 90-day trade war ceasefire fails to materialise, resulting in the re-escalation of a US-China trade war, which will be a major negative for the global and Asean economic outlook.”

How does this affect the local real estate investment trust sector? Lower interest rates and easy money are positive for REITs, but economic headwinds can have an adverse effect, depending on the sector. A dovish Fed could lead to a weaker US dollar. During quantitative easing, a weaker US dollar led to increased liquidity in Southeast Asia. Now, however, there is a caveat to easier monetary conditions. Political volatility — in the form of elections in India and Thailand — may scupper market rallies.

Still, an easier interest rate environment is almost always good for S-REITs. Lower interest rates stymie their interest expense and boost their unit prices, as S-REITs are generally priced off local riskfree rates such as 10-year Singapore government securities if their assets are predominantly in Singapore.

In addition, while there is no definite relationship between interest rates and capital values, lower rates are usually benign or positive for capital values.

Singapore office rents to rise further

According to Edmund Tie & Co (ET&Co), office space was one of the better performers in 2018 compared with industrial, retail and residential. The consultant pointed out that average monthly gross rents in the CBD increased 6.8% to $9.50 psf in 2018. Rents of offices in Marina Bay rose 8.7% to $11.50 psf. Rents of Grade-A buildings in Raffles Place moved up a more moderate 4.2% to $10.00 psf per month in 2018.

Interestingly, ET&Co believes office rents can continue to rise this year because of demand supply metrics. “About 704,000 sq ft and 734,000 sq ft of new islandwide office supply is forecast to be completed in 2019 and 2020 respectively, with 148,000 sq ft in 2019 and 514,000 sq ft in 2020 of new supply in the CBD,” it says. “This is substantially lower than the annual average net absorption rate of 946,000 sq ft over the past three years from 2016 to 2018 in the CBD. Moreover, most of this new supply has been pre-committed.”

The REITs whose assets are predominantly office buildings in Singapore’s CBD are CapitaLand Commercial Trust (CCT), Keppel REIT and OUE Commercial REIT. The three are different in terms of positioning and risk profile. According to sums done by DBS Group Research, last month, “CCT led growth within the Singapore office sector, up 10% m-o-m on the back of strong results and expectations of a continued uplift in market rents ahead. This is closely followed by Frasers Commercial Trust (FCOT), OUEC-REIT and Suntec REIT, which gained 8.8%, 8.7% and 8.4% m-o-m respectively”.

FCOT’s Singapore properties are either on the fringe of the CBD, such as China Square Central, or in the vein of a business park, such as Alexandra Technopark, with the remaining portfolio in Australia and business parks in the UK.

Suntec REIT is a mixed portfolio with significant office space. Its retail portion contributed 28% to FY2018’s net property income and income, and convention contributed a further 6%. Its total office portfolio contributed 66% to total NPI and income while its Singapore office NPI contributed 56% to total NPI and income, with Australia accounting for the remaining contribution.

FCOT’s presence in Singapore shrinks

Last July, FCOT divested 55 Market Street for $216.8 million and a net gain of $75.7 million, leaving it with just two properties in Singapore: Alexandra Technopark and China Square Central. Thus, Singapore comprised just 54% of its assets by value as at Dec 31.

For 1QFY2019 (the REIT has a September year-end), FCOT’s distribution per unit (DPU) — stayed flat y-o-y. As at last December, the occupancy rate at Alexandra Technopark (ATP), including pre-committed leases, was 68.6%.

This included a lease for 93,302 sq ft by Hewlett-Packard Singapore, which comprised 9% of the net lettable area. HP did not renew the lease and has moved to a build-to-suit property owned by Mapletree Industrial Trust. FCOT announced that its manager was carrying out “proactive leasing and asset management strategies to normalise occupancy at ATP as soon as possible”. On the flip side, the retail podium of China Square Central reopens in 2HCY2019, following a one-year asset enhancement initiative (AEI) .

FCOT’s net asset value (NAV) fell three cents y-o-y to $1.56 on Dec 31. The decline, caused by a decrease in unitholders’ funds, was due mainly to the effects of a weaker Australian dollar, and the issuance of units from the distribution reinvestment plan, FCOT said.

Biggest risk: equity-funded acquisitions

The biggest risk among the office REITs would be a value-destroying acquisition. Last month, OUE confirmed that US Bank Tower in Los Angeles was up for sale. The US media reported that the asking price was about US$700 million ($951.4 million). If OUE cannot find a buyer, the building could be offered to OUEC-REIT.

In November, OUEC-REIT completed the acquisition of the office portion of OUE Downtown for $908 million, but the total price paid by unitholders was $955.9 million because of expenses, including fees to OUE.

The purchase was part-funded by a dilutive 83-for-100 rights issue at 45.6 cents a unit, which raised $587.5 million. Although there were valid acceptances for only 95.5% of the rights issue, excess applications ensured they were all subscribed.

The theoretical ex-rights price was 57 cents. As with dilutive rights issues, OUEC-REIT reacted negatively, and unit prices fell to a low of 45.5 cents, which was the rights price. Unit prices have since rebounded. Because of the dilutive impact of the rights issue, which was completed last October, OUEC-REIT announced a 34.4% decline in DPU to 0.75 cent for 4QFY2018, and a 24.5% decline in DPU to 3.48 cents for FY2018. Even before the acquisition, OUEC-REIT had been experiencing a challenging time growing DPU. For FY2017, OUEC-REIT announced a DPU of 4.67 cents, down 9.8% y-o-y.

In the meantime, One Raffles Place — in which OUEC-REIT has an 83.33% stake — is undergoing AEI for the retail podium. Former anchor tenants such as H&M and Uniqlo appear to have vacated. OUEC-REIT also owns OUE Bayfront. DBS is recommending a “buy” on OUEC-REIT as a “tactical play”. This year, unitholders will be able to benefit from a full-year contribution from OUE Downtown. On a pro forma basis, OUEC-REIT announced a DPU of 3.47 cents (for FY2017) based on an enlarged capital base, following the rights issue. It has already met this for FY2018 with a DPU of 3.48 cents.

According to OUEC-REIT’s results, two months of OUE Downtown’s contributions accounted for 14.8% of 4QFY2018 revenue of $48.036 million, or $7.1 million (including income support). Excluding higher rents for this year, OUE Downtown should contribute about $42 million, or 24% of revenue. Inter estingly, the rental cycle is likely to result in positive rental reversions. “OUE Bayfront saw lease expiries committed at between $11.50 and $14.20 psf, bringing its average passing rent to $11.60 psf, from $11.50 psf a quarter ago. Meanwhile, the average passing rent for One Raffles Place stabilised at $9.45 psf,” observes CIMB in a results update. CIMB forecasts FY2019 DPU to be flattish at 3.4 cents.

Management, leasing strategy

CCT announced a DPU of 2.22 cents for 4QFY2018, up 6.7% y-o-y, taking FY2018 DPU to 8.7 cents, up 0.5% y-o-y. Aggregate leverage fell from a high of 37.9% as at June 30, 2018 to 34.9% as at Dec 31. Its portfolio occupancy rate inched up to 99.4%, and tenant retention rate inched down to 77%.

As the owner of the largest portfolio of Grade-A properties in the CBD valued at $10.62 billion, CCT saw its NPI for FY2018 rose 18.5% to $314.6 million.

“The performance is largely due to an increase in rents. A lot of the focus was on retaining tenants, securing better rents, improving occupancy rates and managing our costs,” says Kevin Chee, CEO of CCT’s manager. In addition, CCT continued to implement its portfolio value creation strategy.

In FY2017, CCT acquired Asia Square Tower 2 (AST2) and divested Wilkie Edge and 50% of One George Street. In FY2018, CCT acquired Galileo and sold Twenty Anson. Both AST2 and Galileo are Grade-A buildings, with the former in the local CBD and the latter in Frankfurt’s CBD.

“Our focus is on the type of tenants we continue to serve, and [thus] the buildings we invest in will be prime and Grade-A properties,” Chee says. “We should not be fixated on a particular class of asset, but make sure the asset has good bones and is well located. If we can drive value and grow income and revenue, and drive DPU as a result, unitholders will be happy with that.”

CCT’s FY2018 performance does not mean it is facing no headwinds. HSBC is vacating HSBC Building next year. Chee says: “We’ve said we have [four]options: renovating, [re-letting,] redevelopment or divestment. Our focus is on re-letting, but if it makes sense to do the other three, we will consider. But now the focus is on re-letting. HSBC Building is a gem. You can’t find another property like this with a 999-year lease.”

Chee says the leasing strategy for the portfolio would take into consideration occupancy rates, rents and rental reversions. “These are the strategies we look at: how we manage our lease expiry profile to sidestep spikes in supply, and to do some forward leasing to capture rents. We would be happy to sacrifice occupancy for higher rents, but this must be balanced with vacancy costs,” he explains. “Ultimately, the aim is to attain an optimum level to drive growth.”

Keppel REIT also holds Grade-A properties in the CBD through its one-third stake in One Raffles Quay and Marina Bay Financial Centre Towers 1, 2 and 3, and an 80% stake in Ocean Financial Centre. According to Keppel REIT’s FY2018 presentation, 18.7% of its NPI is from Australia, with the rest from Singapore.

Its DPU for FY2018 fell to 5.56 cents from 5.7 cents a year ago. This was partly due to loss of income support for Ocean Financial Centre, and lower NPI from 275 George Street and 8 Exhibition Street in Australia.

Keppel REIT’s gearing at 36.3% — including perpetual securities, which are defined as equity — is higher than CCT’s. Paul Tham, CEO of Keppel REIT’s manager, says, however: “With the portfolio we have, we are comfortable with higher gearing. We’ve always guided 40% to 42%, and the only reason we’re at that level is the regulatory limit of 45%.”

To lower gearing, Keppel REIT divested 20% of Ocean Financial Centre for $537.3 million last year, recording a capital gain of $77.1 million. “One of the reasons for divesting 20% of OFC was to unlock capital for capital distributions. This is part of portfolio optimisation — selling down a little bit [for] share buyback and reinvesting. Our investors are also asking for more yield,” Tham says.

Keppel REIT’s investors may get a lift in DPU this year. UOB Kay Hian has a “buy” recommendation on Keppel REIT. “The fourth quarter of 2018 is a trough for Keppel REIT, owing to negative rental reversion, as Grade-A office rents peaked three years ago at $11.30 to $11.40 psf pm. This year, Keppel REIT will benefit from a full-year impact of leases renewed at higher rents in 2018,” UOBKH says.

“Keppel REIT achieved average signing rent for Singapore office leases of $11.10 psf pm for 2018, up 12.9% y-o-y.”

Which office REIT is the best?

“The office sector is set to deliver the best reversions and DPU growth, supported by the multi-year supply drought and acquisitions,” DBS says. Which office REIT is the best depends on investors’ risk profiles.

For Singapore, the choice is likely to be between CCT, Keppel REIT and OUEC-REIT. Keppel REIT had a challenge with its Australian portfolio because of the exchange rate. With the dovish central bank statements since the start of the year, however, US dollar strength could recede, and the Australian dollar could strengthen. That would buoy Keppel REIT’s NAV, which fell one cent y-o-y to $1.39 as at Dec 31.

Higher yields inevitably come with higher risk. Local investors who prefer higher yields can opt for REITs with higher risk (see table). Usually, Grade-A buildings are likely to hold their value and appre ciate as well, as institutional property funds prefer these assets, but they tend to have lower capitalisation rates and property yields.

The biggest risk is a rights issue to finance an acquisition because these are rarely yield-accretive. After a rights issue, unit prices are usually under pressure and yields expand, making it difficult for future acquisitions. “Rights issues have usually been destructive to share price performance in the Singapore market in the past,” says Havard Chi, director, Research at Quarz Capital Asia.

CCT’s Chee says: “DPU yield is a function of our share price and, if investors like what we’re doing, the asset class and our strategy of investing overseas, our share price will go up.”

This story appears in The Edge Singapore (Issue 869, week of Feb 18) which is on sale now. Subscribe here