Maybank Securities’ Krishna Guha and UOB Kay Hian’s (UOBKH) Jonathan Koh have maintained their “buy” calls on Keppel REIT following the acquisition of a 50% stake in Sydney's 255 George Street for A$363.8 million ($321 million). Guha has kept his target price of $1.00 while Koh has increased his target price by 2 cents to $1.26.
The REIT’s proposed acquisition of the stake in this Grade-A Sydney central business district (CBD) office, described as an "iconic prime building", is seen as a positive development.
Guha believes that 255 George Street, located in the highly sought-after Core Precinct, will benefit from the flight-to-quality trend.
He adds that the building’s committed occupancy of 93% and an average weighted average lease to expiry (WALE) of 6.8 years have resulted in a promising initial net profit interest (NPI) yield that exceeds 6%.
According to Koh, the Core Precinct has proven to be the best-performing sub-market in the Sydney CBD area, following a “strong” return-to-office recovery since the pandemic.
It holds the lowest vacancy rate of 11.5% among the four key sub-markets within the Sydney CBD. With an increasing office demand, JLL Research anticipates that the new supply of office space will be occupied within one to two years from completion.
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Koh forecasts that these factors will contribute to increasing effective rents, a result of growing face rents for offices and decreasing incentives.
With the REIT’s pro forma gearing at 41% post-acquisition, both Guha and Koh believe that the REIT will step up its capital recycling.
Koh has raised his distribution per unit (DPU) estimates for FY2025 by 1.5% to 6.2 cents after taking into account contribution from 255 George Street.
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At Keppel REIT’s unit price of 87 cents as at Koh’s April 2 report, the REIT is trading at a P/NAV of 0.67 times, which is near the low of 0.61 times on March 23, 2020, at the onset of the Covid-19 pandemic. The current P/NAV represents a 33% discount to its NAV per unit of $1.29.
To Maybank’s Guha, the REIT’s latest move shows that it is taking a “long view” on its portfolio notwithstanding the challenging macro and emerging trend of hybrid working.
“That said, the rental support, capitalized rent incentives, tenant concentration and elevated gearing bears watching unless capital recycling lowers the gearing,” he says.
Meanwhile, Brandon Lee from Citi Research increased his target price for the REIT by 1 cent to 90 cents. That said, he is still keeping his “neutral” call due to the REIT’s total return of 9% based on its current share price.
Calling the latest deal a “relatively decent” one, Lee believes that the acquisition is beneficial to the REIT’s portfolio NPI yield and cap rate, estimated at 3.6% and 3.5% respectively. The current flight-to-quality momentum in the office market within Sydney CBD proves advantageous to the office building, accounting for the REIT’s conviction towards a low vacancy rate.
Nonetheless, Lee notes some negatives to the deal, which includes the vendor providing up to A$46.8 million for rent guarantees (and up to A$5.2 million for 12 months on existing vacant tenancies and 19 months on one specified tenancy which currently occupies two floors or 7% - 8% of 255 George Street), rent abatement/rent-free incentives.
Excluding the rent guarantee, the analyst has forecasted a lower NPI yield of 6.1%.
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Like his peers, Lee also notes that the post-acquisition gearing of 41% also seems beyond investors’ comfort level of 40% and below.
On Feb 21, Mingtiandi reported that the REIT had selected JLL to facilitate the potential sale of T Tower. Lee forecasts that this development could further lower the gearing to below 39% and cause a DPU accretion of an estimated 0.5%.
“We think Keppel REIT’s FY2024 Australia portfolio valuation could be negatively impacted given 255 George Street’s cap rate of 6.5% being higher than its portfolio cap rate of 5.2%”, Lee elaborates.
He has upped his DPU estimates for the FY2024, FY2025 and FY2026 by 0.7%, 1.1% and 1.4% to 5.65 cents, 5.81 cents and 6.09 cents respectively to reflect the news of the acquisition.
