Office Reits

DBS GROUP RESEARCH on 19 June 2012

A MORE tax-efficient structure for MBFC Phase 1 in place: K-Reit and Suntec Reit announced that they had successfully converted the vehicle which holds Marina Bay Financial Centre Towers 1 & 2 and Marina Bay Link Mall Phase I (collectively known as MBFC Phase I) into a Limited Liability Partnership (BFCD LLP) structure. Under the previous structure, both K-Reit and Suntec Reit pay a 17 per cent corporate tax rate on the rental income generated on the property. Upon conversion, the operational rental income (excluding income support) generated by MBFC Phase 1 will no longer be subjected to corporate taxes. The new structure will take effect from June 16, 2012 and is not retrospective.

FY13 DPU to increase by 3.6-5.1 per cent: Based on our estimates, both Reits should reap tax savings of close to $2.2 million and $4.5 million in FY12 and FY13, respectively. Netting off administration fees, we estimate that FY12 DPU should increase 1-2 per cent and FY13 DPU by about 4-5 per cent. We think this conversion is a positive step as it would also pave the way for the possible restructuring of One Raffles Quay (ORQ) into a similar more tax-efficient LLP structure in the longer term. Currently, the payable tax for ORQ is estimated to be close to $3 million per annum.

TP to rise by 7.9-8.6 per cent, upgrade K-Reit to 'buy': Adjusting for the tax savings, Suntec Reit's TP (target price) is raised by 8.6 per cent to $1.58. We continue to like Suntec Reit for its strong balance sheet and we believe the tax savings should help to partially offset the income vacuum of Suntec City Phase 1 AEI works that began in Q2 FY12. We have also upgraded K-Reit to "buy" from "hold". We like K-Reit for its quality assets and we believe the tax savings would help to strengthen its balance sheet. Net of the tax adjustment and factoring in a higher withholding tax for its Australian property, our new TP of $1.21 (up 7.9 per cent) offers investors a total return of 30 per cent.