CapitaLand Commercial Trust: Record office property transactions not indicative of REIT future performance April 20, 2017 1152

PSR Recommendation: NEUTRAL Status: Maintained
Target Price: 1.63
  • Net property income and DPU was within our forecasts.
  • Negligible (5% by gross rental income) of portfolio expiring for rest of 2017.
  • Recent record office transactions and optimistic land tender not necessarily indicative of forward stock price performance for the coming year.
  • Maintain NEUTRAL with unchanged target price of $1.63.

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What is in the news and What do we think?

  • Lesser leasing activity q-o-q as only c.5% of leases is due for expiry this year. Raffles City weakness offset by CapitaGreen contribution.

Recall that CCT has proactively forward renewed half of 2017 expiring leases by end FY16 in December 2016. Only 5% of leases (by gross rental income) are due for renewal in 2017. A notable weakness within the portfolio comes from Raffles City, which saw a 5.3% drop in NPI as a result of lower hotel turnover rent. This was offset by 39.7% increase in NPI from CapitaGreen, post 100% ownership. We expect the pace of decline for Raffles City to improve and keep to our projected 1.6% y-o-y drop in NPI for Raffles City for FY17.

  • Recent slew of transactions reflect optimism at longer term outlook for Singapore office properties. Bullish transacted prices not necessarily indicative of forward stock price peformance. 2016 saw a 103% jump in total physical office investment transaction volume to S$7.5bn from S$3.7bn in 2015. The rekindled interest in office properties, including the record price paid for Straits Trading Building (c.S$3,500psf) has led to renewed optimism about the sector.

We think these physical office transactions reflect the buyers’ optimism at the longer term outlook for Singapore office properties but may not be correlated with the 1-year performance of REIT prices, which are more sensitive to other variables driving short term sentiment such as near term economic indicators.

We note that prior to this record breaking transaction, the previous record paid was S$3,125psf in April 2008 for 71 Robinson Road. That quarter happened to mark the peak of the office price index before the GFC effects set in. The Singapore office price index took 12 quarters before it recovered above that peak level in 3Q11. The FTSE Straits Times REIT Index returned -17.6% over that period.

Figure 1: Previous record price paid for an office property in 2Q08 marked the peak of the office property price index before GFC. Price Index recovered to 2Q08 levels only in 3Q11 (after 12 quarters)

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  • Pace of office rental decline abating. We maintain our view that office rentals should bottom in 2018. Post its peak in 1Q15, average monthly Grade A office rents dropped c.21% from S$11.4 to S$8.95 in 1Q17. However, the pace of decline is starting to slow. We maintain our view that we will see a bottom in office rents only in 1H2018.

Figure 2: Pace of office rent decline abating

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  • Minimal lease expiring this year mitigate downside risk for FY2017. But FY18 could be worse for rental reversions. We expect office rents to recover only in 2018 and negative rental reversions in FY18 to be worse than FY16 and FY17 as most of the expiring leases then are signed close to the peak in office rentals in FY15. c.13% of CCT’s leases expire in 2018. Vacancy risks are low given the central locations of CCT’s properties but property gross revenue could take a hit from lower reversions.
  • Awaiting assessment of differential premium (DP) payable for Golden Shoe redevelopment. URA has given provisional permission for the proposed redevelopment of Golden Shoe. CCT now awaits the Singapore Land Authority’s assessment of the differential premium payable for the potential enhancement in land use before completing its feasibility study of the proposed redevelopment.

Investment Actions

At an FY17e yield of 5.7% and Price/NAV of close to 0.92, CCT is trading close to the average yields of 5.7% and P/NAV of 0.88 since 2010 (post GFC). We maintain our “NEUTRAL” call on CCT with an unchanged DDM-derived target price of S$1.63

Figures 3 and 4: CCT trades at close to post GFC average dividend yields and Price/NAV

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Figure 5: Peer comparison table

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About the author

Profile photo of Tan Dehong

Tan Dehong
Research Analyst
Phillip Securities Research Pte Ltd

Dehong covers primarily the REITs and property developer sector. He has close to 7 years experience in equities related dealing and research roles.

He graduated with a Masters of Science in Applied Finance from SMU and Bachelors of Accountancy from NTU.

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