Office S-Reits may turn from laggards to leaders, says DBS

Singapore

DBS Group Research on Thursday recommended investors "stay with your office winners", as the sector's Singapore-listed real estate investment trusts (S-Reits) look geared for a cyclical recovery.

Furthermore, the overhang from rising flexible work trends could be mitigated by limited new office supply and a pick-up in Singapore's gross domestic product (GDP), wrote analysts Rachel Tan and Derek Tan.

Office S-Reits remain attractive as they are trading at the sector's historical average of 0.9-time price to net asset value (P/NAV), they said in a report. "With a vaccine now within sight, we believe a return to normalcy would be the catalyst to drive office S-Reits' unit prices towards 1.1-times P/NAV, or one standard deviation above their historical average."

As the economy is on the mend from the Covid-19 pandemic, and given the close correlation among GDP, office demand and these S-Reits' stock performance, DBS sees "the office laggards turning into leaders in 2021". Overall, S-Reits' unit prices have recovered about 40 per cent from their March lows, but office

S-Reits' performance - with just a 30 per cent recovery - is still lagging behind that of peers in other asset classes. Office S-Reits thus offer the opportunity for investors to ride the recovery into the next year, said DBS.

Meanwhile, demand for office space is set to emerge with a new face post-pandemic. Firms are adopting more flexible work arrangements, aiming to crystallise occupancy savings in the near term. That being said, DBS believes the level of adoption of hybrid-work models will vary according to sectors and job scopes. Financial institutions and insurance firms, which take up close to 40 per cent of the total space in the central business district (CBD), may return the most office space compared to other sectors, the analysts said.

The potential downsizing in sectors hit hardest by the Covid-19 crisis will also depress net demand for CBD office space. Such firms, mainly in food and beverage, retail, and energy, are tenants of about 20 per cent of CBD offices, DBS said.

According to DBS's scenario analysis, there could be some 1.1 million square feet (sq ft) of negative net absorption, which may translate into shadow space or vacancies in the coming years. CBD office vacancy rates may thus increase to 14 per cent, from the current 12 per cent.

A potentially higher-than-expected economic and employment expansion could counter these headwinds, DBS said. In addition, the limited new supply of offices could prevent a steep decline in rents. Only 167,000 sq ft of net supply will be coming to the market in 2020-2022.

Firms will also need to fulfil safe-distancing requirements in the workplace, expanding the amount of space required per employee by 25 per cent to 100 sq ft, DBS estimated.

Companies that have benefited from the pandemic, particularly those in the technology sector, may see continued growth and thus bring a bigger appetite for offices.

DBS' analysis indicated that these factors will likely result in net demand being at break-even.

While the return of space in the coming years remains an overhang, Grade A offices with property attributes surrounding sustainability will continue to attract tenants and remain resilient, the analysts said.

Their picks are Keppel Reit with a S$1.40 target price, CapitaLand Integrated Commercial Trust (CICT) with a S$2.50 target and Mapletree Commercial Trust with a S$2.25 target.

Separately, Keppel Reit has obtained A$300 million (S$300.7 million) in green loans from UOB and BNP Paribas. Part of the loan proceeds will fund its acquisition of Pinnacle Office Park, a freehold Grade A property in Sydney. The manager expects the acquisition to complete in Q4 2020.

DBS analysts said Keppel Reit has kickstarted its acquisition mode with the Pinnacle deal. They added that the trust is well-positioned to benefit from a recovery in a "very tight" net supply market, and to capture growth from China's tech giants.

DBS also noted that following the merger of CapitaLand's commercial and retail trusts to form CICT, Keppel Reit is now the only pure-office S-Reit - "a valuable trait that investors have yet to appreciate", it said.