Summary: Domestic office rentals peaked in 2H11 and, from channel checks, we judge that Grade A office rentals has declined a further 3-5% in 1Q12. We now forecast office rentals to fall 10-15% in FY12 and believe office capital values could come under pressure ahead. For CCT’s Grade A portfolio, an average cap rate of 4.0% was used by independent valuers in Dec 11, while cap rates around 4.15%-4.5% were used over Jun 08 – Dec 10 (excluding 6BR, HSBC building). In terms of share price, we see key risks stemming from fair value write-downs as the sector softens further, though any price downside is likely capped by a currently undemanding valuation (0.7x PB) and a fairly attractive yield (6.1%) for high-quality Grade A office exposure. Downgrade to HOLD with a lower fair value estimate of S$1.14 versus S$1.29 previously, to reflect softer cap rate assumptions.
Expect office rentals to dip in FY12
Domestic office rentals peaked in 2H11 and, from our channel checks, we believe that Grade A office rentals has declined a further 3-5% in 1Q12. Given continued macroeconomic uncertainties and an ample office pipeline of 4.2m sqft NLA in FY12-13, we now forecast office rentals to fall 10-15% in FY12.
Downside for distributable income likely limited
That said, we think the downside for CCT’s FY12 distributable income is likely limited. Only 7.9% of CCT’s portfolio gross rental income, primarily at 6BR and One George, is due for renewal in FY12 (29.9% in FY13). Also, despite a forecasted decline in office rentals, we would still likely enter a phase of positive rental reversions in 2H12 as leases signed during the previous trough in 2H09-2H10 are renewed at market levels.
Capital values to face headwinds
However, we believe office capital values could come under pressure with softening rentals expectations, accompanied by cap rates expansion, as major players in the market re-evaluate the office cycle. For CCT’s Grade A portfolio, an average cap rate of 4.0% was used by independent valuers during the latest appraisal in Dec 11, while cap rates in the range of 4.15% to 4.5% were used over Jun 08 – Dec 10 (excluding 6BR, HSBC building). Moreover, we think the recent Twenty Anson acquisition was somewhat aggressive at S$2.1k psf (S$430m) since Capital Tower nearby (also owned by CCT) was valued independently at S$1.6k psf in Dec 11.
Risks from fair value writedowns - DOWNGRADE to HOLD
For CCT’s share price, we see key risks stemming from fair value write-downs as the domestic office sector softens further, though any price downside is likely capped by a currently undemanding valuation (0.7x PB) and a fairly attractive yield (5.7%) for high quality Grade A office exposure. Downgrade to HOLD with a lower fair value estimate of S$1.14 versus S$1.29 previously, to reflect softer cap rate assumptions.
Domestic office rentals peaked in 2H11 and, from our channel checks, we believe that Grade A office rentals has declined a further 3-5% in 1Q12. Given continued macroeconomic uncertainties and an ample office pipeline of 4.2m sqft NLA in FY12-13, we now forecast office rentals to fall 10-15% in FY12.
Downside for distributable income likely limited
That said, we think the downside for CCT’s FY12 distributable income is likely limited. Only 7.9% of CCT’s portfolio gross rental income, primarily at 6BR and One George, is due for renewal in FY12 (29.9% in FY13). Also, despite a forecasted decline in office rentals, we would still likely enter a phase of positive rental reversions in 2H12 as leases signed during the previous trough in 2H09-2H10 are renewed at market levels.
Capital values to face headwinds
However, we believe office capital values could come under pressure with softening rentals expectations, accompanied by cap rates expansion, as major players in the market re-evaluate the office cycle. For CCT’s Grade A portfolio, an average cap rate of 4.0% was used by independent valuers during the latest appraisal in Dec 11, while cap rates in the range of 4.15% to 4.5% were used over Jun 08 – Dec 10 (excluding 6BR, HSBC building). Moreover, we think the recent Twenty Anson acquisition was somewhat aggressive at S$2.1k psf (S$430m) since Capital Tower nearby (also owned by CCT) was valued independently at S$1.6k psf in Dec 11.
Risks from fair value writedowns - DOWNGRADE to HOLD
For CCT’s share price, we see key risks stemming from fair value write-downs as the domestic office sector softens further, though any price downside is likely capped by a currently undemanding valuation (0.7x PB) and a fairly attractive yield (5.7%) for high quality Grade A office exposure. Downgrade to HOLD with a lower fair value estimate of S$1.14 versus S$1.29 previously, to reflect softer cap rate assumptions.
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