• Unchanged BUY and SGD1.08 TP, 24% upside and 7% yield. Keppel REIT’s acquisition 255 George Street (255 GS) is a pre-emptive strategy, in our view, to capitalise on recent office asset value corrections in Australia and a potential recovery ahead from rate cuts. While gearing will raise above 40%, we see divestments ahead to bring KREIT’s gearing back to below 40%. It trades at >30% discount to book value, which we believe is unjustified, considering the REIT’s high quality office assets in prime locations.

• Acquisition of 50% stake in 255 GS, Sydney, Australia, from Mirvac Wholesale Office Fund I for a purchase consideration of AUD363.8m (SGD321m). The freehold Grade-A office asset built in 1985 had major refurbishments done in 2022 and comes with strong environment credentials (5.5 Star National Australian Built Environment Rating System or NABERS energy rating). Committed occupancy stands at 93% with a relatively long weighted average lease expiry or WALE of 6.8 years and diversified tenant base. Management guided on first year net property income (NPI) yields based on acquisition costs be at mid-6% levels. However, this does include a rent guarantee (AUD5.2m) for 12 months on existing vacancies and potential expiries, and a 19-month period from 1 Dec 2024 for one specific tenancy, excluding which we believe the NPI yield is closer to 6% levels. Post this acquisition, Australia will account for c.19% of total assets (up from 17% currently), with Singapore assets still making up the bulk of KREIT’s portfolio at 77%.

• Flight to quality remains a key trend driving the Australian post-COVID-19 central business district (CBD) office demand, with vacancy rates at Sydney’s core CBD market remaining low at 11.5% vs other submarkets. JLL Research also expects prime office face rents to rise with a likely reduction in incentives.

• T Tower divestment likely on the cards, with KREIT currently marketing the asset for sale, according to media reports. Management said it continuously evaluates its portfolio for asset recycling opportunities. T Tower was valued at KRW205.8bn (SGD320m) based on a 4.2% cap rate. Hence, a sale at slight premium to valuation or c.4% cap rate could provide a healthy yield spread of c.200bps if proceeds are recycled to above acquisition. The acquisition, in the meantime, would be fully funded by debt (estimated debt cost of slightly >4%) and results in overall gearing to increase to 41%. Based on 100% debt funding, KREIT expects pro-forma (FY23) yield accretion at c.1.4%.

• We revise our FY24F-26F DPU by 1%, factoring in acquisition and associated debt funding. KREIT’s 3.2 ESG score is a notch above the country median. Hence, a 2% ESG premium is applied to our DDM-derived TP.

Source: RHB Research - 3 Apr 2024