The Positives
+ Portfolio occupancy remain unchanged at 95.2% QoQ, 176,000 sqft (3% of portfolio) of leases signed with positive rental reversions. Dip in occupancy in RCS (-1.0ppts) was offset by Asia Square Tower 2 (+0.8ppts) and Six Battery Road (+0.2ppts). Rental reversions ranged +0.4% to 26.1%, calculated as the average of newly signed rent over average expiring rents. New leases signed accounted for 13% of NLA committed in the quarter. Lower leasing activity in 2Q as physical viewing of space was suspended and only resumed in Phase 2 (19 June). 8% of leases expiries by GRI remain for FY20. Occupancy at Six Battery Road stands at 78.7% and has not been back-filled post-downsizing by Standard Charted Bank. The asset will undergo $35mn worth of AEIs which are expected to be delayed by 3-4 months due to delay in construction works. Prolonged lower occupancy expected as leasing can only commence after the space is ready.
+ FY20 refinancing completed, lowering average cost of debt from 2.3% to 2.2%.
The Negatives
- Portfolio valuation fell marginally by 1.7%. While cap rate assumptions were unchanged, lower valuations were the result of lower market rents and rental growth rates assumptions due to economic uncertainties and COVID-19.
- Construction delays to push back viewing/leasing activity and WeWork lease. Due to heighten regulation mandating the provision of twin-sharing accommodation for foreign workers, AEI works at Six Battery Road and 21 Collyer Quay has not commenced while the construction for CapitaSpring has resumed.
Outlook
While the leasing environment remains weak, average expiring rents for FY20-FY22 range $9.08 to $10.95 is lower in comparison to current market rents (CBRE: $11.15). Modest positive rental reversion is still achievable.
CCT committed $25.8mn in rental waivers in 1Q20, excluding additional rebates for the estimated 20% of qualifying SMEs tenants. To date, CCT has booked:
Germany portfolio largely resilient with no rental waivers granted.
$22mn of rental deferment were provided to all tenants, the bulk of which went to hotel operators in the RCS (JV) portfolio. Deferment was for hotel rents for the period April to September 2020, with the scheduled repayment to commence from January 2021.
Maintain ACCUMULATE with unchanged TP of S$1.91.
Headwinds persist for the office asset class. However, we believe offices will remain relevant in the evolving world of technology and telecommuting. The value added by office will evolve from being merely a physical workstation to a space synonymous with mentoring, collaboration, corporate culture and creativity. No change in our estimates. CCT offers a FY20e/21e DPU yield of 4.5%/5.3%.
The Positives
+ c.10% of lease expiries for the year remain, 60% of FY20’s expiries committed. CCT signed approx. 303K sqft of leases in 1Q20 with positive reversions ranging 0% to 31%. 22% of leases signed were new leases with demand coming from Financial Services, Legal Energy, Commodities, Maritime and Logistic sectors. With weaker economic sentiments, leasing demand is expected to be muted, with more renewals than new leases expected.
The Negatives
- Portfolio occupancy fell from 98.0% to 95.2%. This was largely attributed to lower occupancy at Six Battery Road (-20.2ppts from 98.7% to 78.5%) due to AEIs following the anchor tenant’s (Standard Charted) downsizing upon lease expiry in January 2020. Occupancy at Raffles City Tower also fell by 5ppts QoQ from 97.2% to 92.2%.
Outlook
CCT will be passing on property tax rebates at the respective rates to all their tenants; Retail and F&B tenants (mostly under RCS) will be receiving approximately 2 months of rental rebates (property tax rebate inclusive). RCS will waive turnover rent for the hotel operators for the month of April (variable rent accounted for 22% of rents from hotels operators in FY19).
Two properties will be undergoing AEIs in FY20 - partial closure of Six Battery Road after and full closure of 21 Collyer Quay after the end of HSBC’s lease in April 2020. Capex costs expected to be $35mn and $45mn respectively.
Upgrade to ACCUMULATE with lower TP of S$1.74 (prev. $2.18).
We lower our FY20e/21e forecasts to factor in lower occupancy from weaker demand in the near-term and the lower revenue from RCS due to the tenant support initiatives. FY20e/21e DPU was lowered by 15.0% and 10.9% respectively. Our cost of equity is raised from 6.34% to 7.25% after raising our beta by 13bps and lowering our terminal growth assumption from 1.85% to 1.6% to factor in the increased market risk and weaker leasing demand.
The Positives
+ Positive rental reversions ranging 4.4% to 27.5% above the average expiring rent. With office rents still growing, albeit at a slower rate (2Q19: 1.3% vs 1Q19: 3.2% QoQ), CCT was able to capture positive rental reversions. Reversions ranged 4.4% to 27.5% above the average expiring rents.
+ AEIs at 21 Collyer Quay and 6 Battery Road to give ROI of c.9% and c.8%. AEI at 21 Collyer Quay comes after a 14-year master lease to HSBC (ending April 2021) and capitalises on transitional occupancy downtime, before the lease to We Work kicks in early 2Q21. The AEI will cost S$45mn and the refreshed building will be able to command higher rents, giving an estimated 9% ROI. S$35mn AEI to create a new through-block link with F&B units in the retail podium, and reconfigure space in levels 3 to 10 of the office block. The office tower will remain in operation and while the AEI is conducted in phases from 1Q20 to 3Q21. ROI of c.8% is expected to come from better floor configuration as well as new F&B tenants in the podium block.
+ New seven-year lease of 21 Collyer Quay to We Work commencing early 2Q21 (post-AEI). This will put CCT’s exposure to co-working operators at 7%. The lease has no break clause and periodic rental step-ups.
The Negatives
- DPU disruption is possible as revenues affected by the lack of income during AEI. 21 Collyer Quay will not be generating cash rents during the AEI and fit-out period from 2Q20 to 2Q21. However, the long runway until 2Q20 gives CCT the ability to grow revenues to offset maintain DPU stability. If approved, the proposed acquisition of MAC (elaborated below) and subsequent completion in 4Q19 will help to grow and stabilize DPUs. Options to distribute capital gains and tax savings exist which the management can explore. However, the management has also expressed that their focus will be on longer-term growth over transitional disruptions to DPU.
- A slight dip in occupancy, mainly due to AST2. Occupancy at AST2 fell 2.3pp from 98.1% in 1Q19 to 95.8% in 2Q19, due to non-renewal of a single tenant.
What else was new?
The proposed acquisition of 94.5% effective stake in Main Airport Centre (MAC), an 11-story office building located in near the 3rd busiest airport in Frankfurt, Germany. Total acquisition outlay is expected to be S$390 and translates to a 4.0% NPI yield (based on committed occupancy of c.90%) and pro-forma 1H19 DPU accretion of 1% (40% debt) to 2.5% (100% debt). Pro-forma leverage expected to increase from 34.8% to 35-37% and will increase CCT’s exposure to Germany from 5% to 8%.
Marco conditions for the airport submarket look positive with vacancy rates for the airport submarket (4.0%) consistently lower than the broader Frankfurt office market (7.5%). The airport submarket rents are also competitive relatively to CBD districts. (€25.5 vs €27.1 psm/month).
This proposed acquisition comes one year after the acquisition of Galileo, CCT’s first foray overseas, located in the Frankfurt CBD Banking district. CapitaLand will hold the remaining 5.5% stake in Galileo. If approved by the unitholders at the September 2019 EGM, the acquisition will be headed for a 4Q19 completion.
CCT has closed the private placement of c.102mn new units for $220mn, 98.5% or S$216.7mn will be used to partially fund the acquisition of MAC. Without further equity raising, the LTV for this acquisition will be c.56%.
Outlook
Outlook remains positive for CCT, with expiring rents for 2019 and 2020 on the downtrend ($10.35/$9.60 psf, 2021: $10.69 psf), below the average market rent of $11.30. Average annual supply of office space coming onto the market from 2019 to 2023 (0.8mn sqft) is 27% lower than the 10-year average supply of 1.1mn sqft and should help to support rents and deliver positive rental reversions for CCT.
Maintain NEUTRAL with higher TP of $2.18 (prev. $1.93).
We revise our forecasts to incorporate newly announced AEIs, new shares from placement to fund the acquisition of MAC, and the proposed acquisition of MAC. Our higher TP of $2.18 is partly due to the items previously mentioned, and a downward revision of our COE from 6.76% to 6.34%, due to the lower interest rate environment. We maintain NEUTRAL due to the run-up in prices year-to-date and the expensive valuation of >2 std. dev P/NAV which CCT now trades at. Our TP translates to a distribution yield of 4.1% and limited upside of 1.5%.
The Positives
+ Healthier margins at AST2, CCT’s largest contributing asset. Huge ramp-up in occupancy levels for AST2 in 1Q19 (90.5% when acquired in 4Q17 to 98.1% in 3Q18) is delivering the topline improvement. NPI margins at this property have also seen a sizeable uptick. NPI Margin stood at 77.5% for 1Q19 compared to 76.7% in 1Q18. AST2 accounts for 27% of net property income.
The Negatives
- Slight dip in occupancy, mainly due to Six Battery Road. Occupancy at Six Battery Road took a hit, from 100% in 4Q18 to 97.6% in 1Q19, due to non-renewal of a single tenant. Upgrading works are also underway for this asset.
Outlook
Outlook remains positive for CCT, with expiring rents on the downtrend for the rest of 2019 and 2020. Macro catalysts include the CBD Incentive Scheme introduced in the URA’s Draft Master Plan 2019, which offers higher plot ratios for older buildings for certain areas within the CBD. Office landlords such as CCT could benefit from the potential tightening of an already-tight Grade A CBD supply.
Downgrade to NEUTRAL with TP of S$1.93.
We downgrade our rating to NEUTRAL due to the recent positive price movement, which has exceeded our target price level. The broad-based run-up in REIT prices year to date can mainly be attributed to the dovish stance communicated by the Federal Reserve as well as the lifting of the sunset clause on tax incentives for S-REITs. Our target price remains unchanged at S$1.93, which translates to a distribution yield of 4.8% and a P/NAV of 1.05x.
