Real estate groups may gain by selling Singapore properties now to buy assets overseas later

HIGHER interest rates are driving asset valuations down in many markets, with negative implications for several Singapore-listed property plays.

Singapore-listed Manulife US Reit saw the valuation of its US’ office assets fall 14.6 per cent between end-2022 and end-June 2023. This came after a year-on-year fall in portfolio valuation of 10.9 per cent as at end-2022.

Ho Bee Land , which owns various prime office buildings in London, UK, posted a fair value loss of S$201.9 million for its London portfolio in 2022. The group suffered a net loss in the first half, primarily due to an unrealised fair value loss of S$208.3 million for the London portfolio and higher interest costs of S$76.3 million. 

For its financial year ended Mar 31, Stamford Land saw a fair value loss of S$75.8 million on its commercial building in London. The group owns 8 Finsbury Circus, an office-cum-retail property located in the City of London.

Frasers Property has said that it will take a hit to its results for FY2023 ended Sep 30, which are to be announced on Nov 10. This is due to fair value losses from commercial properties in the UK, and industrial and logistics properties in Europe.

As interest rates rise, so do capitalisation rates – the annual return an investor expects from an investment.

Using the income capitalisation method to calculate a property’s value means dividing the assumed net property income by its capitalisation rate. A property’s value is therefore inversely related to the capitalisation rate used.

Exacerbating the woes of office building owners are shrinking leasing demand due to economic weakness, and smaller office space requirements as employees spend much time working remotely.

Key overseas commercial property markets may not be out of the woods yet. For example, market watchers do not expect commercial real estate prices in the US to hit bottom until H2 2024 or later.

In contrast, Singapore’s commercial property market has been an outlier.

Keppel Reit saw the valuation of its Singapore portfolio, which is dominated by Grade A office space, rise by S$39 million over the last six months to S$7.24 billion as at end-June. The capitalisation rates used to value the assets ranged between 3.25 per cent and 3.55 per cent.

Will this trend continue? Or is the Singapore property market due for a slump even as overseas markets rebound?

Selling Singapore property

Local property groups might do well selling Singapore properties in the near term, as demand is strong.

Recently, UOL Group ’s subsidiary inked a deal to sell shares in the company that owns the property comprising Parkroyal on Kitchener Road – a 542-room hotel in Little India – and New Park Shopping Arcade. The deal priced the property at S$525 million, or 24 per cent above its end-2022 valuation.

With hardly any distressed sales of investment properties, Singapore is a seller’s market. Meanwhile, commercial property yields are low.

Take, for instance, an owner earning S$30 million yearly in net property income (NPI) from an office building that is funded by S$300 million of debt at a cost of 4.5 per cent per annum. The owner earns S$16.5 million after financing costs.

Assume the building sells for S$1 billion, representing an NPI yield of 3 per cent, and net proceeds after transaction costs amount to S$960 million. After paying off the loan, the vendor pockets S$660 million. 

If this S$660 million is placed in fixed deposits and Treasury bills for an annual return of 3.6 per cent, it earns S$23.8 million – 44 per cent more than owning the building.

Overseas opportunities

The cash could also be deployed abroad, especially in major cities such as London.

Property investing is generally a long-term game that rewards an owner who is not forced to sell assets at inopportune times. Much of the gains in property investment are made from timing the market.

Assume prices of premier office buildings in London slip further over 2024 before rising 50 per cent over the next decade, with the bulk of gains made in 2025 and 2026. Such a recovery could be driven by lower interest rates and the city drawing diverse businesses in fast-growing sectors.

In the above scenario, the big winners are buyers of London office buildings in late 2024 or early 2025.

The business world is replete with stories of gusty calls creating enormous fortunes. Possibly, the time will be right soon for strong players to seize distressed property opportunities in markets such as Australia, China, the UK and the US.

In recent history, holding Singapore investment properties has paid off for many owners.

Yields are skinny and contribute to groups reporting low returns on equity. Nevertheless, some owners can still enjoy upside from carrying out redevelopment or asset enhancement works.

Also, there is no risk of foreign exchange losses from the Singapore dollar strengthening against other currencies. And, high-quality assets tend to hold their value as money is attracted to safe-haven Singapore.

Even so, there could be an opportunity cost to tying up monies in stable Singapore assets and not redeploying it into opportunities abroad.