• Rents and macro indicators encouraging
• Yield still elevated
• Slightly lower FV of S$1.53

Singapore CBD Grade B Tailwinds Intact

On the back of more favourable demand-supply dynamics, Grade A CBD landlords continue to exert greater bargaining power over asking rents. However, we believe that the positive spill over effect that this has on Grade B assets should not be discounted by investors.

According to Colliers, 1Q18 average gross effective rents at Grade B premises in Raffles Place / New Downtown saw a 3.5% QoQ increase while those in Shenton Way / Tanjong Pagar registered growth of 4.2% QoQ. This is particularly encouraging, since about 43.3% of China Square Central’s leases by gross rental (excluding the 18 Cross Street retail podium) will be expiring in FY19, which would give Frasers Commercial Trust (FCOT) a timely opportunity to ride this wave.

We also note that 1Q18 CBD Grade B vacancy registered a marginal increase of 0.2ppt QoQ to 6.8%, which appears to indicate a tapering of the flight-to-efficiency trend, typically characterised by tenant relocations to newer buildings within the Grade A space.

Broad economic trends look encouraging too, as the Ministry of Trade and Industry has announced that Singapore’s GDP grew 4.4% in 1Q18, beating the 4.3% advance estimate. Furthermore, Singapore’s 2018 economic growth forecast range has been revised from 1.5% - 3.5% to 2.5% - 3.5%, on the back of a slightly improved external demand outlook.

Valuations Supportive, But Conservative on DPU

FCOT’s current FY18F dividend yield is at 7.0%, which we believe could compress further, given the significantly lower forward yield of ~5.5% registered at the start of the last rental recovery cycle in 1H 2013.

Still, despite the encouraging upward trend in spot rents, we believe that the level of DPU in the near term will still depend on the support drawn from the distribution of capital gains arising from the previous disposal of the hotel development rights for China Square Central.

As we would prefer to be surprised on the upside, we incorporate more conservative assumptions for the aforementioned distribution, and reduce our FY18F and FY19F DPU forecast by 2.2% - 2.9%. Thus, we adjust our fair value slightly from S$1.54 to S$1.53.

Source: OCBC Research - 2 Jul 2018