Here’s why investors should stay away from office REITs in 2016

Supply-demand dynamics will still be shaky.

The worst is not yet over for Singapore office REITs as turbulent supply-demand dynamics are expected to plague the sector in 2016.

According to a report by RHB, for the past three quarters, Grade A rental rates have dropped about 9% from its peak of $11.40 psf per month in 1Q15. This is due mainly to the expectation of high office space supply in 2016; the global economic slowdown; and the flagging demand from both the commodities and O&G industries.

Further, up to 4.2m sqft of office space is expected to be completed this year, reflecting a 6.2% YoY climb in total stock. On a 10-year historical average, net demand for office space is about 1.2m sqft. As the incoming 4.2m sqft of office space is around 3.5 times more than this average, it may take at least four years for this space to be absorbed.

It is also likely that waning demand will persist as the global economic climate remains weak and highly uncertain.

RHB notes that Guoco Tower and Duo Tower have only managed to commit about 10% and 25% respectively of their total net lettable areas (NLAs).

As both towers comprise a large chunk of 2016’s supply pipeline, the low level of tenants’ commitments raises concern. This may cause overall office rental market to further drop by up to 15% this year.

However, 2018 will likely be a turnaround year for the office space segment.

“In our view, we think that rental rates should hit rock bottom by end-2017, as most of the office supply is expected to be completed only by 4Q16,” notes RHB.

In addition, there is likely to be a tight supply situation in 2018, given that there is only one office tower that is slated to be completed that year. Therefore, office rates should bottom in 2H17.