Singapore: Real Estate: REITs - Office sector: Near-term headwinds, medium-term value; stay selective

Near-term headwinds cloud office outlook...
In the near term, office trends continue to deteriorate faster and sharper than we initially expected as supply concerns loom, with the Marina Bay sub-sector experiencing the most weakness given 1.9mn sqft of supply from Marina One in end-2016/early-2017 and pressure from tenant relocations to decentralized areas (e.g., Google, potentially Microsoft).

The decline in Grade A spot rents accelerated in 3Q, -3.5% qoq to S$10.90psf (2Q: -0.9% qoq), as landlords lowered asking rents to maintain occupancies and extend leases ahead of new supply. While the proactive lease renewals have brought forward the decline in spot rents, we think this also means that rents are likely to see the steepest decline in 2015 before easing (i.e., a more gradual decline) in 2016.

Consequently, we revise our FY15/16E spot rent forecasts to -8%/-5% yoy (previously -3%/-3% yoy) before recovering (+3%) in 2017E. This implies a 14% decline from the peak in 1Q15 to the trough in 2016, similar to the previous 14% decline in rents in the 2011-2013 down cycle.

Cyclical not structural; valuations have reset
In the medium term, however, we think the office sector offers value: a pre-eminent ASEAN financial hub with a dynamic growth path, and limited supply beyond 2016 (until at least 2020). We think the market has discounted the decline in rents, with CCT and KREIT trading +0.5 SD above midcycle dividend yields and at implied NPI yields of 5.5%/5.1% vs. current cap rates of ~4%.

Further supporting our view is the resilient market for office transactions. Notably, negotiations are underway for Asia Square Tower 1 potentially for S$2,800-3,200psf (Straits Times, Oct 14), implying still-tight cap rates and support for book values.

Technical Analysis
Daily Chart
Downside support; CCT top office pick
CCT is our top pick amongst office SREITs (S$1.77 12m TP, 25% upside potential), offering the most direct exposure to the office sector (no overhang from rental support expiry or retail exposure). On average, we revise our TPs by -7% and DPU by - 5%/-8%/-10% for FY15-17E for office SREITs on the back of our changes in rent forecasts. (Read Report)

Source : Goldman Sachs Equity Research

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