DBS Group Research analysts Rachel Tan and Derek Tan say that economic headwinds could moderate office rent growth momentum going into 2023, despite its “good run” in 2022.
The Singapore office sector saw its Grade A core central business district (CBD) rent surpassing its pre-Covid high of 2019 with a 7.2% increase in 9M2022. Average rents of $11.60 per square foot per month (psf/month) also surpassed pre-Covid highs in 2019. Office and commercial S-REITs share prices hit their peak in August after re-rating by 15% since
the beginning of the year, outperforming other asset classes as of September — before the sentiment turned.
“Unfortunately, the share price outperformance was short-lived, weighed down by macroeconomic concerns and the Fed pushing on its aggressive rate hikes, raising 75 basis points (bps) in its third and fourth consecutive hikes in September and November. Thus, it resulted in a divergence of share price underperformance on strong underlying outperformance
in the office sector, especially after 3QFY2022,” say Tan and Tan.
They point out that office and commercial S-REITs have the highest gearing ratio in capital management among the other asset classes of S-REITs at an average of 40.5%, which is a key concern in a high interest rate environment. “Although it is only slightly above the 40% gearing level, it has raised some concerns given that interest rates may stay high longer than expected.”
Among the office and commercial S-REITs, Suntec REIT ranks the highest risks on capital management with a gearing ratio at 43%, the lowest interest coverage ratio (ICR) at 2.5 and the lowest hedging ratio at 56%. “Suntec’s management believes that gearing could remain at 45% but would prefer divestments to weather through this period to reduce balance sheet risks, should the need arise,” explain Tan and Tan.
Going into 2023, the analysts say they expect slowing economic growth to weigh on the sector. They note that the Singapore economy is expected to slow to 2.2% in 2023 from an expected gross domestic product (GDP) growth in 2022 of 3.5%, dragged mainly by the manufacturing sector, with also the service sector to possibly run out of steam going into 2023.
Say the analysts: “While our DBS economist expects growth momentum to slow in 2023 and inflation to remain sticky at around 6.3%, driven partially by the hike in Goods and Services Tax (GST) starting Jan 1, 2023, Singapore’s economy may avert a recession, perhaps technical recession, if any, within the next three quarters.”
According to them, the electronics cluster, which has been an important driver of Singapore’s growth, is losing impetus due to falling global demand. The latest October non-oil domestic exports (NODX) is a good bellwether for the manufacturing sector and the Singapore economy, which showed a headline number that dipped into the red, decreasing 5.6% y-o-y, for the first time in almost two years, dragged by poor electronics export sales, which decreased by 9.3% y-o-y, and a deep 32% decline in exports to China.
On the other hand, financial services could be weighed down by weaker global demand, higher risk premiums, and margin erosion. As such, the analysts say that IT and financial services, which are the two key drivers of Singapore’s office market, could be impacted with a challenging global economic condition going into 2023.
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Meanwhile, the general landscape for the tech and financial layoffs — which has seen substantial layoffs in recent months — will still be manageable for the Singapore office sector. “While tech has been aggressively expanding its office footprints in the past few years, it takes up only around 10% to 11% of Singapore CBD offices. Assuming it scales back all its expansion, vacancy could rise to 3.9% from the current 3.1% as at September, which is still below the historical average of 4.6%,” say Tan and Tan.
Conversely, the financial sector has been downsizing its office space, with a decrease of 2% points while expanding its workforce by 3% to 4% each year. “As such, we do not expect major downsizing from the financial sector in the near term. However, vacancy risks will rise if a prolonged recession becomes evident,” they add.
Suntec and Keppel REIT are the most exposed to the financial and tech sectors, comprising around 65% and 54% of their tenants in Singapore respectively. Meanwhile, CapitaLand Integrated Commercial Trust (CICT) has more exposure to financial, tech and real estate sectors. Accounting for real estate and property services, including flex operators, Suntec remains the highest at around 73%, followed by CICT at around 70%.
For the DBS analysts, the “silver lining” that could keep the Singapore office sector afloat will be China’s reopening — which could prove to be a “game-changer”. “With the recent relaxation of Covid-19 policies in China, we are hopeful that the reopening of China is in the works, albeit with uncertain timing. Assuming that China reopens after March 2023, our DBS economist believes that this could be the key driver for economic growth especially in the 2H2023 that could possibly bring GDP growth back to above 3%, assuming the global economic and geopolitical situation remains status quo and does not worsen,” they say.
“The exuberance and economic recovery with China could likely lead to its second leg of growth for the Singapore office sector,” they add.
On top of China’s reopening, they believe that Singapore is in a unique position to see support for its office market, after raising its global rank as a destination for regional headquarters and family offices. Between 2019 and 2021, there were 700 new family offices set up in Singapore, while more than 100 new family offices were approved between January and April this year.
The analysts say they prefer Mapletree Pan Asia Commercial Trust (MPACT) and CICT as key beneficiaries of China’s reopening. “The CBD malls in MPACT and CICT will see another leg of growth driven by tourists from China post-border reopening. MPACT’s Festival Walk may see recovery back to pre-Covid levels, which is currently around 20% to 30% below pre-Covid levels, as the Hong Kong-China borders reopen,” they explain.
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Both MPACT and CICT are offering 5.5% and 5.6% to 5.7% FY2023 and FY2024 dividend yields respectively. On price-to-book value ratio (P/BV), MPACT is trading at 0.9x, 1 standard deviation (s.d.) below its historical mean while CICT is trading at 1x, close to 0.5 s.d. below its historical mean.
Tan and Tan have “buy” ratings for each of CICT, MPACT, Suntec REIT and Keppel REIT, with target prices of $2.20, $2.00, $1.60 and $1.15 respectively. The remaining stock under DBS coverage for the Singapore office sector is OUE Commercial REIT, which has a “hold” rating and a target price of 35 cents.
As at 2.50pm, units in CICT, MPACT, Suntec REIT, Keppel REIT and OUE Commercial REIT were trading at $1.99, $1.61, $1.37, 89.5 cents and 33.5 cents respectively.
