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

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SINGAPORE – DBS Group Research on Thursday (Dec 10) 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-working trends could be mitigated by limited new office supply and a pickup in Singapore’s gross domestic product (GDP), said analysts Rachel Tan and Derek Tan in a report.

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), the analysts wrote. “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-time 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 in 2021”.

Overall, S-Reits’ unit prices have recovered about 40 per cent from their March lows, but office S-Reits’ price performance – with just a 30 per cent recovery – is still lagging that of peers in other asset classes such as industrial and hospitality. Office S-Reits thus offer the opportunity for investors to ride the recovery into the next year, DBS said.

Meanwhile, demand for office space is set to emerge with a new face post-pandemic. Firms are increasingly looking to adopt more flexible-working arrangements, with the aim of crystallising occupancy savings in the near term, the research team noted.

That being said, DBS believes that the level of adoption of hybrid-work models will vary according to sectors and job scopes, as there is no one-size-fits-all arrangement.

Financial institutions and insurance companies, 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, Ms Tan and Mr Tan added.

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

What may counter the headwinds led by the to hybrid working is a potentially higher-than-expected economic and employment expansion, DBS said.

In addition, the limited new supply of office space could prevent a steep in rental rates. Only about 167,000 sq ft of net supply will be coming to the market in 2020-2022.

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

Moreover, companies, particularly those in the technology sector, that have been beneficiaries of the pandemic may see continued growth and thus an increased appetite for office space.

DBS’s analysis indicated that these factors, taken together, will likely result in net demand being at break-even.

The research team pointed out that employers are still reviewing their plans, and might make firmer decisions in the next few years as their leases come up for expiry.

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 (MCT) with a S$2.25 target.

As at 11.24am on Thursday, units of Keppel Reit were flat at $1.05, CICT was up $0.02 or 1 per cent to $2.10, while MCT $0.01 or 0.5 per cent to $2.09.

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