KEPPEL real estate investment trust (Reit) has posted a 5 per cent increase in property income to S$172.6 million for its first nine months ended Sep 30, 2023, up from S$164.4 million in the corresponding period of the previous year.

 

The improved performance was supported by higher rentals and increased portfolio occupancy, its manager said in its key business and operational update for the third quarter of 2023 on Tuesday (Oct 17).

 

Distributable income from operations, however, fell 10.1 per cent to S$148.6 million for 9M 2023, due to higher borrowing costs, higher property tax and utility costs. These were partially offset by the higher property income and rental support, said Keppel Reit.

 

Net property income attributable to unit holders went up 0.3 per cent to S$120.4 million from the previous year. 

 

The Reit&rsquo s portfolio weighted average lease expiry remains at 5.6 years, with approximately 1,103,800 square feet (attributable area of 561,900 square feet) in leases committed in 9M 2023.

 

Committed occupancies for the portfolio rose to 95.9 per cent in Q3, up from 94.9 per cent in the second quarter, added its manager.

 

The Reit said its weighted average signing rent for its office leases in Singapore rose from S$12.35 per square feet per month (psf pm) in H1 2023 to S$12.43 psf pm in 9M 2023. Its Singapore office portfolio comprises Ocean Financial Centre, Marina Bay Financial Centre, One Raffles Quay and Keppel Bay Tower.

 

As at the end of September, Keppel Reit&rsquo s aggregate leverage stood at 39.5 per cent, with 76 per cent borrowings on fixed rates. 

 

The manager said no major refinancing is required for the rest of this year, and the majority of debt due next year will mature in Q2 2024. Refinancing discussions with the lenders have been initiated.

 

The Reit has approximately S$1 billion in available borrowing facilities to meet its short to medium-term funding requirements, it said.

 

Keppel Reit said it remains focused on delivering sustainable long-term total returns to its unit holders, and that its manager would continue to proactively manage the portfolio and be prudent in managing capital.

 

US CREDIT rating agency Equifax is now the anchor tenant for Keppel real estate investment trust&rsquo s (Reit) new Blue & William office development located in North Sydney, its manager said on Tuesday (Oct 10).

 

Equifax occupies more than 4,350 square metres across the fifth and seventh levels of the property, which is a third of the building&rsquo s net lettable area. It moved from two separate offices in the North Sydney area.

 

The manager noted that almost half of Blue & William&rsquo s office space has been leased. Other tenants include Northbrew Cafe and global consulting firm Human Synergistics, which will move in early next year.

 

Keppel Reit acquired Blue & William in December 2021. The 10-storey development is located at the intersection of Blue Street and William Street. Lendlease is the development and investment manager.

 

DBS Group Research estimates that Blue & William contributes about 4 per cent to 5 per cent of Keppel Reit&rsquo s attributable net property income on a full occupancy basis, the group said.

 

It added that the opening with a strong first anchor tenant bodes well for the Reit, and said the manager is strategically being selective regarding tenants to ensure income visibility during this period.

 

Despite achieving half committed occupancy, the Reit has a three-year rental guarantee from Lendlease, DBS noted.

 

It maintained its &ldquo buy&rdquo recommendation on the counter and target price of S$1.15. The research team said Keppel Reit is trading close to a yield of 7 per cent and nearly two standard deviations above its historical range.

 

DBS said Keppel Reit&rsquo s price could be weighed down by investors who take a cautious stance on the near-term continued rise of interest rates.

 

&ldquo However, we believe at these levels, it is an attractive level for a medium-term outlook and for a turn in the interest-rate-hike cycle,&rdquo DBS said.

 

With its one-third stake in Grade A offices such as Marina Bay Financial Centre and One Raffles Quay and 79.9% of Ocean Financial Centre, Keppel REIT&rsquo s Singapore assets make up much of the city-state&rsquo s CBD skyline. 

 

To DBS Group Research, Keppel REIT &mdash the only office pure-play Singapore REIT (S-REIT) &mdash offers a best-in-class office portfolio whose value REIT investors &ldquo have yet to appreciate&rdquo . Among the office REITs and mixed REITs, Keppel REIT has been among the best performers, losing less than 6% this year. 

 

Keppel REIT stands out for investors because it is one of only two S-REITs with an active unit buy-back programme that has received a positive response from investors. In 1HFY2023, Keppel REIT bought back and cancelled 19.65 million units, of which 10.15 million were bought back in 2QFY2023. 

 

Unit buy-backs are accretive for Keppel REIT as its net asset value (NAV) is at $1.31 as at June 30, and its distribution per unit (DPU) yield based on its 1HFY2023 DPU translates to 6.6% based on the average buy-back price of around 87.5 cents. 

 

As at June 30, Keppel REIT&rsquo s gearing is at 39.2%, which may curtail its ability to continue with its buy-back programme. In April this year, the REIT&rsquo s mandate from its unitholders on its unit buy-back programme enabled the manager to buy-back 10% of units in issue or 375.5 million units.  

 

According to CGS-CIMB, the buy-backs help Keppel REIT maintain &ldquo its flexibility in utilising unit buy-backs and capital distributions as part of its capital management strategy as well as managing its gearing level&rdquo , enhancing ROE, DPU and offsetting short-term speculative trading along the way. 

 

Capital management

 

Since Koh Wee Lih was appointed as the CEO of the REIT&rsquo s manager in December 2021, he has focused on capital management. In October 2022, Keppel REIT announced a special distribution of $100 million over the next five years leading up to its 20th anniversary in 2026. Keppel REIT will distribute $20 million annually, which unitholders will receive semi-annually. 

 

In addition, Koh has been trying to keep the REIT&rsquo s hedge ratio steady despite big changes in the environment of interest rates. While the ratio increased from 63% at the end of 2021 to 71% at the end of the first quarter of FY2022, it has been maintained at around 75% and ended at approximately 76% at the end of FY2022. 

 

He has also managed to maintain Keppel REIT&rsquo s low cost of debt during the year, although that is likely to increase as the months wear on. &ldquo For example, before the interest rate hikes, in 2019 and 2021, we issued five-year convertible bonds and seven-year medium-term notes (MTN) at very attractive rates of 1.9% and 2.07%, respectively,&rdquo Koh says.

 

Overseas acquisitions

 

In October 2022, Keppel REIT acquired KR Ginza II in Tokyo, a freehold office building comprising eight storeys of office space and a retail unit on the ground floor, with a total net lettable area (NLA) of 3,427.1 sqm (36,889 sq ft). In July, a new tenant from the energy sector committed to three floors in KR Ginza II, bringing the committed occupancy from 36.3% to around 75%. When fully leased, the property is expected to bring a net property income (NPI) yield of approximately 3.1% and pro forma DPU accretion of 0.5%. 

 

&ldquo For our recent Japan acquisition, we have entered into interest rate swaps to fully hedge our interest rate exposure, which protects us from the recent Bank of Japan&rsquo s position to increase its cap on the long-dated interest rate curve,&rdquo Koh continues. &ldquo Our all-in cost of debt of 2.84% per annum for 1HFY2023 is lower than the prevailing reference rates, which is a testament to our effort in managing our borrowing costs.&rdquo  

 

CGS-CIMB expects funding costs to rise, as they have with most S-REITs. &ldquo Regarding funding cost, at the current interest rate level, average funding cost could trend closer to mid-3%.&rdquo  

 

Keppel REIT was also one of the first Singapore-focused REITs to expand overseas. Its foray into Australia was back in 2010 with the acquisition of 77 King Street in Sydney and 50% of 275 George Street in Brisbane. In 2016, the REIT divested 77 King Street. In 2021, it divested 275 George Street. It now owns six Australian properties.

 

Diversification often reduces risk in a portfolio. Still, the Australian dollar has weakened against the Singapore dollar by more than 30 Australian cents (26.3 cents) since then. Some market watchers expect a rebound in the Australian dollar should Chinese demand return. 

 

The weaker Australian dollar versus the Singapore dollar was evidenced in the six months to June 30 by the 3.5% decline in the valuation of the Australian portfolio in Singapore dollars compared to a 1.1% gain in the valuation of the Australian portfolio when valued in Australian dollars for the period between Dec 31, 2022, and June 30.

 

Diversified tenant and asset base 

 

Koh maintains that the REIT&rsquo s portfolio will remain anchored by Singapore assets, accounting for 79% of the total as of June 30. &ldquo We believe having 25% to 30% of overseas assets complements Keppel REIT&rsquo s Singapore-centric portfolio and increases Keppel REIT&rsquo s ability to deliver stability and sustainable growth through property cycles in individual countries,&rdquo he adds.

 

A few of Keppel REIT&rsquo s Australian properties have single-tenant leases with long weighted average lease expiries (WALEs), typically with the government. For example, the David Malcolm Justice Centre in Perth is leased to the high court for 25 years, and the Victoria Police Centre in Melbourne is leased to the police department for 30 years. &ldquo Both leases have fixed annual rental escalations and rent review at predetermined anniversaries,&rdquo offers Koh.

 

Additionally, Keppel REIT boasts a diversified tenant base with over 440 tenants. Besides government agencies, many are blue-chip financial firms such as DBS, BNP Paribas and Standard Chartered, which are among the top 10 largest tenants by NLA. The State of Victoria accounts for 9.8% of NLA, and the Government of Western Australia comprises 4.1% of the REIT&rsquo s NLA. 

 

While the REIT&rsquo s Singapore assets are at full or near-full occupancy rates, those in Australia are less so. Out of six properties in Australia, 8 Chifley Square, Pinnacle Office Park, and Blue & William &mdash all in Sydney &mdash have committed occupancies of 87.4%, 90.2% and 37.7%, respectively, as of June 30. There are signs of improvement, though, with Koh noting that the Australian portfolio has improved on a q-o-q basis, with 8 Chifley Square and Blue & William securing new tenants. 

 

The REIT managed to do so by introducing new fitted-out office spaces, which generated &ldquo strong interest&rdquo among potential tenants as they could move in more quickly. &ldquo We are looking at doing more fitted offices to increase our leasing velocity and occupancy further,&rdquo Koh says.

 

Occupancy commitments

 

The REIT&rsquo s strategy appears to be effective. As of June 30, committed occupancy was 94.9%, and the REIT achieved over 850,000 sq ft of space commitments with a healthy rental reversion of 8.1% in the first half of this year. Average signing rates for Singapore increased to $12.35 psf per month in 1HFY2023, up from $12.05 psf per month in 1QFY2023.

 

In the view of DBS, Keppel REIT is in a favourable position to capitalise on a potential recovery in a tight net supply market, which is expected to last till 2024.

 

When asked about the tenant risk, Koh says the creditworthiness of tenants is assessed before signing lease agreements, adding: &ldquo We maintain a proactive approach to monitor the tenant credit risk exposure and ensure mitigation measures are in place should the risk impact become material. 

 

Credit risks are further mitigated through the upfront collection of security deposits. Systematic rental collection procedures are implemented to ensure regular collection of rents, thereby minimising rental arrears and default risk.&rdquo  

 

Managing these risks holds even greater significance in the current environment, which is less favourable for REITs to pursue acquisition and growth strategies. &ldquo Acquisitions remain challenging in the near term with negative spreads between cap rates and funding cost in most of its geographic footprint, except Japan,&rdquo reports CGS-CIMB. 

 

That may be a good thing: The market frowns upon acquisitions because accretion is challenging, and equity and cost of capital, in general, are expensive. Keppel REIT is in a good place as it finds that buying back its units is the best value.   

 

CGS-CIMB analysts Lock Mun Yee and Natalie Ong have maintained their " add" call and $1.14 target price on Keppel REIT.

 

While the REIT' s office portfolio might see some pressures because of changing working habits, the analysts, in their Sept 25 note, hold the view that with FY2023 yield already at 6.8%, much of the downside has already been factored in.

 

At a recent roadshow organised by CGS-CIMB, Keppel REIT&rsquo s management remains the most upbeat on its Singapore portfolio.

 

" Keppel REIT allayed investors&rsquo concerns over the structural change in office take-up due to the hybrid work-from-home trend by sharing that its Singapore properties do not have any shadow space," state Lock and Ong.

 

According to the analysts, signing rents for Singapore properties are at $12-15psf. As such, the REIT will likely enjoy positive rental reversions in the second half of this year, based on the average expiring rents of $11.55psf in 2023, $11.06psf in 2024 and S$11.11psf in 2025. 

 

Separately, Keppel REIT expects the occupancy rates of its Australia properties to improve in 2HFY2023 too.

 

In addition to a new government tenant at 8 Chifley Square and a new banking sector tenant at Blue & William, there continues to be leasing interest and anticipates committed occupancy in its Australia portfolio to continue to improve towards end-FY23F. 

 

In addition, rents at some of its Sydney properties have started to strengthen while tenant incentives have compressed marginally. 

 

In Japan, backfilling of space by an energy sector tenant has lifted occupancy at KR Ginza II property to 75%. Office rents in South Korea' s continuing to trend up as well.

 

Keppel REIT maintains that potential acquisitions " remain challenging" in the near term with negative spreads between cap rates and funding cost in the majority of its geographic footprint. The exception is Japan.

 

Thus, to deliver unitholder value, management indicated that it would focus on growing DPU and close the wide 32% gap between share price and NAV of $1.31 as at June 30. 

 

To this end, the REIT had bought back 19.65 million units at an average of 87.5 cents, and cancelled these units, equivalent to 0.5% of the total in 1H23.

 

" Management maintains its flexibility in utilising share buybacks and capital distributions as part of its capital management strategy as well as managing its gearing level," the analysts note.

Meanwhile, average funding costs, at current levels, could trend closer to mid-3%, up from 2.84% at end of 1HFY2023, suggest Lock and Ong.

 

Potential re-rating catalysts include the redeployment of capital proceeds to new accretive acquisitions and recovery of demand for office space to pre-Covid levels. 

 

On the other hand, downside risks include longer-than-expected frictional vacancy from tenant movements and reduced appetite for its office space due to a hybrid work environment.

 

DBS Group Research on Thursday (Aug 31) said that it sees a tactical opportunity for Keppel Reit : K71U +0.58% units as the timeline for Keppel Corp&rsquo s distribution of the real estate investment trust&rsquo s units progresses.

 

Keppel Corp : BN4 +1.31% announced on Jul 27 that its shareholders would receive one Keppel Reit unit for every five Keppel Corp shares held to mark the conglomerate&rsquo s 55th anniversary.

 

Contrary to common belief, the research team observed that a counter subject to a distribution tends to go up rather than down in the period between the initial announcement date and completion date.

 

This was the case for CDL Hospitality Trusts and CapitaLand Ascott Trust (Clas), it noted.

 

&ldquo While past observation is no guarantee of future performance, we are cautiously optimistic that the same behaviour may pan out for Keppel Reit,&rdquo DBS noted.

 

DBS believes that the Reit&rsquo s unit price may exceed its assumed completion price after the distribution is approved at a shareholder&rsquo s meeting, which usually occurs around two months after the initial announcement.

 

DBS is projecting an upside towards S$0.96 for the counter, 10 per cent higher than Keppel Reit&rsquo s last trading price of S$0.87 as at 4.10 pm on Thursday. The counter was up 1.2 per cent or S$0.01 at the time.

 

The research team took into account the resilient outlook of the Singapore office market, Keppel Reit&rsquo s &ldquo best-in-class&rdquo portfolio, an anticipated end to the Federal Reserve rate hike cycle, as well as Keppel Reit&rsquo s attractive valuations.

 

The Reit is currently trading at 0.65 times its book value and a forward yield of 6.8 per cent.

 

Keppel REIT K71U -0.55% has secured a new renewable energy solutions tenant at KR Ginza II, formerly known as Ginza 2-chome, in Japan.

 

The new renewable energy solutions tenant will occupy three floors, spanning approximately 14,100 sq ft, announced the REIT&rsquo s manager on July 31. With this, the building&rsquo s committed occupancy has increased from 36.3% to nearly 75%.

 

KR Ginza II is a freehold boutique office building in Tokyo&rsquo s prime Ginza District, which was acquired by Keppel REIT in November 2022. KR Ginza II is currently anchored by Netyear Group Corporation, a subsidiary of NTT Data Corporation.

Completed in 2008, KR Ginza II comprises eight storeys and offers a total net lettable area of about 37,000 sq ft with a retail unit on the ground floor. The building is located within the Chuo ward, one of Tokyo&rsquo s core five wards and home to major Japanese corporations, the Bank of Japan and the Tokyo Stock Exchange.

 

The REIT manager says vacancy rates are &ldquo trending towards the tight levels seen pre-pandemic&rdquo , with pre-leasing for office buildings &ldquo largely encouraging&rdquo . &ldquo The manager is confident that with its proactive leasing efforts, KR Ginza II will continue attracting companies looking for quality office spaces in Tokyo.&rdquo

 

Keppel REIT acquired the office building with a purchase consideration of 8.83 billion yen ($83 million) for its 98.47% effective interest.

Keppel Reit units: To have and to hold &ndash or not? 

ACCORDING to the conventional wisdom &ldquo don&rsquo t look a gift horse in the mouth&rdquo , one ought to be grateful and not question the value of a gift. But why not?

 

A case in point is &rsquo s emerald (55th) anniversary reward to shareholders by way of an unexpected proposed special dividend in-specie of 352.4 million units it owns in (KReit).

 

This proposed distribution represents a 9.4 per cent interest in KReit &ndash one of the largest pure-play office S-Reits listed on the Singapore Exchange with a portfolio of S$9.2 billion, more than three-quarters of which is located in Singapore. The rest of the quality commercial assets under management by the Reit, which is sponsored by Keppel&rsquo s wholly-owned Keppel Land, are in key business districts in Australia, South Korea and Japan.

 

Keppel&rsquo s proposed distribution of one KReit unit for every five Keppel shares, announced alongside its first-half FY2023 bumper profits of S$3.6 billion, is set to make entitled shareholders wonder what to do once they bag the perk.

 

The plan is subject to getting shareholders&rsquo green light at a meeting to be held by end-year, while the final value of the dividend in-specie will be based on KReit&rsquo s unit price on the date the proposed distribution is completed. Based on KReit&rsquo s last traded price of S$0.92 prior to the announcement, the special dividend is worth S$0.184 per Keppel share.

 

Keppel said the proposed distribution of KReit units is part of the company&rsquo s ongoing capital management following its reboot &ndash unveiled in May &ndash from a conglomerate to a global asset management and operator. The exercise will also raise KReit&rsquo s public float and investor base.

 

No doubt, the anniversary theme is dominant among Keppel&rsquo s group of companies. On its part too, KReit said last October that it will set aside S$100 million from accumulated capital gains to be distributed once every six months. It will take place over the next five years to mark its 20th anniversary in 2026.

 

The beat goes on, albeit slowed

 

Here&rsquo s one context for Keppel&rsquo s latest move.

 

The group has set a goal to monetise assets worth S$10 billion to S$12 billion by end-2026. Under this plan, aimed at scaling up and driving growth as well as rewarding shareholders, Keppel has so far announced deals to unlock value of nearly S$5 billion. These include some S$420 million announced over the six months to June 2023.

 

The capital recycling is part of Keppel&rsquo s efforts to meet a return on equity (ROE) target of 15 per cent by 2030. The company is hopeful this can be hit even earlier &ndash by 2026 &ndash as it supplants lumpy earnings with recurring income, which it appears to be doing dutifully. Already, 76 per cent of its first-half FY2023 net profit stemmed from recurring income from half in the corresponding period the previous year.

 

However, the pace of capital recycling has visibly slowed in the last six months versus the previous years since Keppel embarked on the programme (S$1.5 billion in 2022 S$1.7 billion in 2021 S$1.2 billion in 2020).

 

The proposed distribution in-specie of KReit units, albeit one off, will enhance Keppel&rsquo s ROE while helping the group stay on message that it remains steadfast on stepping up its ROE game.

 

What next?

 

That could also partly explain the elephant in the room, so to speak, since Keppel announced the proposed distribution: Why is Keppel cutting its stake in KReit to 37 per cent at this point, even if it will remain its largest unitholder? And is this is a prelude to something more?

 

When queried on this matter at last week&rsquo s results briefing, Keppel chief executive Loh Chin Hua replied: &ldquo ...if there is anything planned after that? The short answer is no. Nothing is planned. We are quite comfortable with this number.&rdquo

 

He also said: &ldquo I hope that many of our shareholders will continue to hold this very good Reit... the assets are best-in-class in Singapore, in Australia. And of course, I think we are quite sure that (KReit) is what we want to hold at this point.&rdquo

 

The market, however, seemed less believing. Following the announcement, KReit&rsquo s units fell 1.6 per cent or S$0.015 to S$0.905 last Friday (Jul 28), largely owing to concerns on the overhang of some 352.4 million units involved in the proposed distribution.

 

Grade A pitch

 

For fans of quality Grade A office assets and those fixated on steady yields of around 6 per cent, there is little to nothing to dislike about KReit as an investment opportunity.

 

KReit&rsquo s latest results underscored continued rosy demand for quality office assets in its markets. As at end-June 2023, overall portfolio occupancy rate remained high at 94.9 per cent. In Singapore, committed occupancies for Ocean Financial Centre and One Raffles Quay were at 100 per cent, while Marina Bay Financial Centre and Keppel Bay Tower were above 98 per cent. 

 

Weighted average lease expiry (Wale) &ndash a gauge of a property portfolio&rsquo s risk of going vacant &ndash stood at 5.7 years. The Wale based on its top 10 tenants is at 10.3 years.

 

To top things off, KReit has also been buying back its units, which offers support for the counter. In the first half, it bought back and cancelled 19.5 million units, with management signalling that it continues to see good value in its units.

 

Several factors hold promise for KReit, said analysts, from resilient rents and capital values for office properties in Singapore to potential catalysts such as redeployment of divestment proceeds to new accretive acquisitions and recovery to pre-Covid demand for office space.

 

On the other hand, while rental reversions at around 8 per cent presently are healthy, the latest data from CBRE Research indicated that Singapore&rsquo s rental market outlook is looking flat.

 

There are other risks, such as a prolonged slowdown in economic activity that could hamper demand for office space, and a sharper-than-expected rise in interest rates that could increase cost of debt and negatively impact earnings.

 

It is no surprise, then, that when the proposed distribution finally gets the nod from Keppel shareholders, the question that will hog the market&rsquo s attention is whether the KReit units under the distribution will be a gift that keeps on giving.