Despite flat office rents, Reits set to enjoy positive rental reversions

AFTER an impressive two-and-a-half year run, Singapore CBD Grade A office rentals appear to be taking a breather.

JLL's gross average monthly rental value for its CBD Grade A office rental basket stood at S$10.81 per square foot (psf) in the fourth quarter of 2019, unchanged from the preceding quarter.

All in, the average rental value has risen 28.5 per cent from the recent trough of S$8.41 psf in Q1 2017.

CBRE's average Grade A Core CBD rental value too has appreciated 29.1 per cent from the recent low of S$8.95 psf in Q2 2017 to S$11.55 psf in Q4 2019.

Most property consultants expect CBD Grade A rents to be flattish this year. By some counts, office completions will still be limited in 2020 and 2021. However, this factor may be offset by declining net new demand against the backdrop of weaker economic growth.

For the past two years, the flexible workspace (coworking facilities and serviced office) providers and tech companies were the two biggest drivers of office demand.

However, for this year, some property consultants are saying that it may not be so clear just yet, as to what the key drivers of office demand will be.

For one, flexible space demand tailed off in the fourth quarter of last year in the aftermath of coworking giant WeWork's aborted initial public offering.

Despite the projection of flattish CBD Grade A office rents this year, most office real estate investment trusts (Reits) will continue to see strong positive rental reversions this year as expiring leases would have been signed in 2016/2017, close to the office rental trough, argue DBS analysts Derek Tan and Rachel Tan in their report "In pursuit for dominance" issued last month.

For instance, JLL's average monthly CBD Grade A office rental value was in the range of S$8.41 psf to S$9.17 psf during the Q1 2016 to Q4 2017 period.

Let's look at an actual example. Keppel Reit can probably look forward to positive rental reversion. The trust reported a weighted average signing rent of S$12.15 psf a month for the leases in its Singapore office portfolio concluded in the first nine months of FY2019.

This should offer a decent buffer to the weighted average expiring rents of S$9.59 psf for 2020, S$9.53 psf for 2021 and S$10 psf in 2022.

On the demand side, concerns continue to linger that co-working operators, which have already built up significant portfolios in Singapore over the past few years, could be heading for a period of consolidation.

This presents a potential risk of shadow space - excess space made available for subletting or reassignment by tenants.

Well, by industry observers' accounts, the major flexible space providers are faring relatively well in Singapore vis-a-vis some other markets because one, the Republic is a global gateway city and two, the government has made efforts to nurture start-ups, for which co-working operators provide a viable space solution.

In addition, even the more established corporates including MNCs have taken to expanding their footprint in Singapore through a co-working facility, for instance, if they need to increase their headcount for short-term projects/contracts.

This is a more flexible option and spares the corporates from incurring capital expenditure - compared with the traditional route of taking a lease directly from a landlord.

There may also be other factors that could lead to things panning out better for the Singapore office market this year than thought.

The DBS analysts point to some of the possibilities including stronger-than-expected economic growth with the US-China Phase 1 trade deal; and stronger-than-expected net office demand from a potential increase in interest from occupiers based in Hong Kong currently.

Moreover, net new office supply could turn out to be lower than expected with some existing stock potentially being removed for redevelopment following the "recent CBD rejuvenation drive by the government with plot ratio incentives".

Planned redevelopments in the pipeline include Keppel Towers and Keppel Towers 2 in Hoe Chiang Road and RB Capital Building along Malacca Street, noted the DBS analysts.

All things considered, things may not be so dour for the office market this year.