Valuations for office Reits lag counterparts, but re-rating may face uncertainty

OFFICE real estate investment trusts (Reits) have been some of the more unloved asset classes in the Singapore market, with the sub-sector trading at a steep discount to its book value.

Reits that derive their revenue predominantly from the office sub-sector are trading at over a 50 per cent discount to their book value on average, dragged by weakness from those with overseas assets in the US and Europe.

By comparison, the average price-to-book (P/B) ratio for the S-Reit sector is around 0.7.

While the situation is not as dire for office S-Reits with mainly local assets, they too have been laggards in terms of their trading valuations.

Keppel Reit trades at around a 35 per cent discount to its book value, while others such as OUE Reit and Suntec Reit are currently trading at around half their book value.

Their P/B ratios are below their five-year historic average, and the Reits also trade at distribution yields above their historic mean, Bloomberg data showed.

Darren Chan, senior research analyst at Phillip Securities Research, noted that Singapore office Reits are currently trading below the FTSE Reit Index P/B ratio of 0.88 times.

“We think the discrepancy in public market valuations for Singapore office Reits and valuations of office buildings is justified with the high level of interest costs and weaker outlook,” he said.

Veteran Reits investor and chairman of GCP Global Gabriel Yap noted that office Reits players such as Suntec Reit have seen their discounts widen, even as the sub-sector has been trading at a discount to net asset value (NAV) for over a decade now.

The muted valuations for local office players come despite stable fundamentals in the sector, unlike the performance of office assets in other countries.

Stable fundamentals

Bloomberg reported last month that office rents in Singapore reached a 15-year high in the first quarter, defying the commercial property slump plaguing other major financial hubs.

Gross effective monthly rents for premium office space in the central business district (CBD) jumped to average S$11.42 per square foot per month in the first three months of the year, according to research from real estate consultancy Jones Lang LaSalle.

While rents are currently at a high, market watchers expect further growth to slow going forward.

Maybank analyst Krishna Guha noted that spot rent growth has slowed for Singapore Grade A offices in the CBD.

“Supply is currently limited but will pick up towards the end of the year or first quarter of next year,” he observed.

However, he added consultants have earlier noted that shadow space has shrunk.

“If economic growth picks up in the second half, sector dynamics may improve on cyclical basis. Demand may also come from displaced tenants in some recent en bloc sales,” Guha said.

Meanwhile, Chan from Phillip Securities noted that core CBD Grade A office rents are expected to plateau to around S$11.90 per square foot per month.

He observed that additional office supply of around 2.9 million square feet would come later this year, mainly from IOI Central Boulevard Towers and Keppel South Central.

“We also expect vacancies to pick up in 2024 with tenants downsizing and more layoffs in the uncertain economic environment,” he said.

A key criterion for the sector to re-rate would be an improvement in the rate environment, said analysts.

Re-rating

“The main factor for re-rating would be faster interest rate cuts, but that would affect all Reits – not only office,” Chan said.

“For office, we will need to see higher demand for office space from tenants, and full work-from-office mandates from employers might help,” he added.

Apart from a sustained cut in interest rates, Maybank’s Guha also believes that there needs to be a “significant improvement in business outlook” for the sector to re-rate.

He added that managers could consider more active capital recycling to realise the discount to NAV and improve their balance sheets.

Others also see room for managers to take a more active role in narrowing the discount.

GCP Global’s Yap noted that managers could buy back more shares if gearing permits.

He added that managers should also “stop making acquisitions which are marginally positive to distributions per unit (DPU) but disadvantageous to minority shareholders or burden them with minimal margin of safety”.

Meanwhile, RHB analyst Vijay Natarajan believes that different management models could be beneficial for some Reits.

He pointed out in a report this month that there are “strong merits” in internalising Suntec Reit’s manager due to its sizeable portfolio of S$12 billion in assets under management, and historically limited reliance on its sponsor for acquisition and fundraising.

“We believe that internalisation could be a win-win for all stakeholders and result in a healthy DPU uplift over the long run,” he said. “This in turn should narrow the huge trading discount.”