The majority of new office supply in 2024 has been absorbed, and concerns of an office downturn are unlikely, says DBS Group Research analyst Dale Lai.
“Initial concerns surrounding the 2 million sq ft of new office supply were overstated, as the two major developments that contributed most of the stock have achieved healthy pre-commitment rates of 70% without any major disruptions to the overall market,” writes Lai in a Dec 12 report.
According to data from the Urban Redevelopment Authority, core central business district (CBD) occupancy rates have declined by 1.2 percentage points (ppt) y-o-y, due mainly to the addition of IOI Central Boulevard. Lai thinks the remaining vacancies at IOI Central Boulevard could be taken up in less than a year.
With supply being absorbed and no significant new developments expected in the core CBD for the next three years “at least”, Lai thinks Grade A rents in the core CBD will continue their upward trajectory “ahead of expectations”.
The supply squeeze should result in higher rental rates for the overall Grade A core CBD market, and landlords will be “well-positioned” to continue achieving positive rental reversions and promptly backfill vacancies.
The only major new supply expected in 2025 — Keppel South Central in Tanjong Pagar, with 613,500 sq ft of office space — will be in the CBD fringe, which is likely to put pressure on offices that are outside of the core CBD and in the more decentralised precincts, adds Lai.
See also: Brokers’ Digest: SGX, UOB, Marco Polo Marine, Pan-United Corp, Food Empire, PLife REIT, Wilmar
Meanwhile, Shaw Tower on Beach Road has been delayed to 2026, and will add 435,000 sq ft of office space to the CBD fringe.
Rate cut beneficiaries
Office S-REITs continue to be heavily weighted on Singapore assets. Approximately 77% of office S-REITs’ portfolios are concentrated in Singapore assets, with Australian properties following with over 7% of total portfolio values, says Lai. Consequently, the performance of office REITs is significantly influenced by the office market fundamentals in these two regions.
See also: SAC Capital has an optimistic outlook on Winking Studios
Sydney and Perth have experienced healthy growth in both rents and occupancy rates during FY2024. However, the Melbourne and Adelaide submarkets face challenges from an oversupply of office space, leading to declining rents and high tenant incentives, adds the analyst.
Office REITs remain among the more highly leveraged subsectors, with an average gearing of around 40.5%. Despite this, other capital structure metrics have remained stable.
The average interest coverage ratio (ICR) stands at a relatively healthy 2.7x, while refinancing risks appear manageable, according to Lai.
On average, only 13%-16% of loans are due for refinancing in the next two years, and all-in borrowing costs are currently at about 3.7%, suggesting that financing costs are close to peaking as interest rate cuts pick up speed, says the analyst.
If interest rate cuts of 100 to 150 basis points (bps) materialise in 2025, office REITs are poised to be the biggest beneficiaries due to their higher leverage levels, says Lai. “Their earnings are the most sensitive to changes in financing costs, making potential rate reductions a significant catalyst for improved profitability and portfolio valuations. These factors collectively position office REITs for enhanced resilience and growth opportunities in the medium term.”
Keppel REIT (KREIT) stands out as the top pick within the sector, says Lai. “As the only pure-play office landlord with a majority of its Singapore portfolio based in the core CBD, we believe KREIT will be the main beneficiary due to upward pressure on rents and occupancy.”
For more stories about where money flows, click here for Capital Section
In addition, KREIT’s overall portfolio occupancy rate of 98.0% reflects strong performance of its Singapore and overseas assets, according to Lai. “Currently trading at a P/NAV multiple of below 0.7 times and offering a forward yield in excess of 6.8% (one of the highest among peers), we believe KREIT remains attractive.”
With further interest rate cuts expected in FY25, savings in financing costs will be another catalyst that will drive upside to our current projections.
Lai has a target price of $1.15 on KREIT. As at 2.32pm, units in KREIT are trading 0.5 cents lower, or 0.6% down, at 85 cents.
Charts: DBS
