• Beneficiary of continued office rental growth
• See downside risks from retail segment
• FY15F yield -1 SD from 5-year average

Suntec REIT to benefit from positive office momentum

The momentum for prime office space in Singapore remains robust, as illustrated by the 3.3% QoQ and 14.7% YoY increase in Grade A rentals in 3Q14, based on data from CBRE. We expect Suntec REIT to be a beneficiary of this trend, as approximately 69% and 68% of its NPI and NLA are contributed by the office segment, respectively. Notwithstanding this positive environment, we believe the pace of rental increase would moderate next year. Growth is expected to ease further in 2016, given the large pipeline of supply coming on stream (~3.9m sq ft). Market watcher Knight Frank has projected a 6%-7% YoY rise in rental rates for prime office space by 4Q15, before softening to overall rental growth of less than 6% per annum in 2016 and 2017.

But retail headwinds pose challenges

The situation appears less sanguine for Suntec REIT’s retail segment, in our view, underpinned by headwinds facing Singapore’s retail sector. This has resulted in the relatively lacklustre committed occupancy rate of 60% (as at 30 Sep 2014) for Suntec City Mall’s Phase 3 development. We see downside risks to our FY15 gross revenue and DPU forecasts if the situation remains sluggish.

Share price performed well; downgrade to HOLD

Suntec REIT’s share price has appreciated 26.0% YTD, outperforming the STI and FTSE ST REIT Index by 21.0 ppt and 17.3 ppt, respectively. We believe the potential for further yield compression could be limited at this juncture, as the stock is now trading at FY14F and FY15F distribution yield of 4.8% and 5.6%. The latter is close to one standard deviation below its 5-year average forward yield of 6.2%. In terms of yield spread over the Singapore Government 10-year bond, the current value of 3.4% is 0.8 ppt below the 5-year average of 4.2%. Given the aforementioned factors, we downgrade Suntec REIT to HOLD, with an unchanged fair value estimate of S$1.90.

Source: OCBC Research - 12 Dec 2014