Headwinds Ahead, Initiate at SELL

• Keppel REIT (SGX:K71U) has emerged as the only pure play office S-REIT following the CCT-CMT merger in Nov 2020, with a significant exposure to Singapore Grade-A offices. Its outlook remains challenging given uncertainties in office demand amid the macro downturn and work-from-home (WFH) entrenchment.
• We continue to see headwinds for leasing out vacancies and at pressured rents, especially in the coming quarters as firms reassess options post-COVID, and anticipate further downsizing by its financial institution tenants (c.36% of its NLA).
• Keppel REIT’s distribution (DPU) growth is unexciting versus peers, and we initiate at SELL with a S$0.90 DDM-based target price (COE: 7.1%, LTG: 1.0%).

Potential Tenant Downsizing, Weakening Office Rents

• Keppel REIT's ;easing remains slow in 3Q20 with no leasing progress of the upcoming UBS vacancy (2% of portfolio income, 20% pre-committed), but management indicated it is in the final negotiation stages with potential tenants.
• Rental reversion at +15% was strong but moderated from +22% in 4Q19 and 19% in 1Q20 due to low expiring rents, while weighted average signing rents were higher q-o-q with the signing of smaller spaces.
• We do not expect this to sustain, as rents remain under pressure from upcoming vacancies, exacerbated by demand erosion from WFH arrangements.

Pivoting Towards Longer WALE in Australia

• Keppel REIT has been pivoting towards rental stability with the recent Australian acquisitions offering longer WALE. 311 Spencer Street, completed in Jul 2020, is fully leased to the State of Victoria for 30 years to serve as headquarters for the Victoria Police.
• Keppel REIT's recent expansion into Sydney’s Silicon Valley, with the acquisition of Pinnacle Office Park for AUD306.0m (S$303.3m) at an initial 5.25% NPI yield and a 4.8-year WALE, however sees it competing for similar suburban offices with AREIT.

High Gearing, Limited Acquisition Catalysts

• Keppel REIT's gearing rises to 37% after the acquisition of Pinnacle Office Park and an issuance of S$300m perpetual securities at 3.15%, (S$150m was utilised to redeem its expiring 4.98% perpetuals), with look-through leverage remaining high at 40% limiting debt headroom.
• Acquisition growth remains challenged by its high trading yield versus tighter office yields, with deals likely to dovetail with its sponsor plan to monetise S$3-5b in assets, including Keppel Bay Tower and Keppel Towers, which has been earmarked for redevelopment.

Sector Report on Singapore Office REITs

• Singapore Office REITs - Maybank Kim Eng 2020-12-15: Working In A New Normal ~ Fundamentals Weak; Work-From-Home A Structural Negative.

Source: Maybank Kim Eng Research - 15 Dec 2020