Why are office rents suddenly the hottest topic in the property market?

Everyone has been buzzing about it.

According to Maybank Kim Eng, the office REITs segment was recently abuzz with renewed interest from investors after the Urban Redevelopment Authority’s Office Property Rental Index recorded a ~1% YoY increase in rent for both the Central Area and Central Region in both 3Q13 and 4Q13.

The uptick came on the back of four consecutive quarters of YoY decline since 3Q12.

How will rents be affected by this? Will the office space market benefit from it in the long run? Here's what analysts think:

Ong Kian Lin, analyst, Maybank Kim Eng:

While we anticipate a reprieve from new office space next year, the fact remains that there is still ample supply – an estimated 6.4m sq ft of net leasable area in the Central Business District (CBD) is expected to come on-stream in 2014-2017. With the labour market moderating and overall hiring expectations on the wane, we do not think headcount numbers will jump sharply this year, especially considering the sub-trend GDP growth and financial services activities remaining sluggish. We estimate net absorption during this year and next would balance out previous outstanding (~4.8m sq ft in the Central Area) and new incoming supplies, leading to an occupancy rate of 90-92% in the Downtown Core (4Q13: 90%). However, in 2016-2017, occupancy rate could slide to 88-90% as ~5m sq ft of new office space becomes available.

We attribute the rental rate rise to slower office completions in 2013, with Asia Square Tower 2 (780k sq ft of net lettable area or NLA) being the only development in the Central Area to obtain a Temporary Occupation Permit (TOP) in 3Q13. This came almost more than a year after the last major Grade A office buildings were completed, namely, One Raffles Place Tower 2 (TOP: 2Q-3Q12) and Marina Bay Financial Centre (MBFC) Tower 3 (TOP: 1Q12). Since early 2013, office landlords have taken advantage of the relative lack of new supply to hold rents steady, with leasing activities for the most part driven by small-space occupiers from the energy and commodities, professional services and IT sectors. Demand from large-space occupiers was more muted as the financial sector kept a tight lid on costs. This in turn helped Grade A completions such as MBFC Tower 3 and Asia Square Tower 1 to progressively fill up to over 90% occupancy rate. Booking.com, for example, took up 45k sq ft recently at MBFC Tower 3. Asia Square Tower 2 is also 60% filled to date, with Mizuho Bank and Allianz as the anchor tenants alongside other tenants such as Swiss Re, National Australia Bank and Nikko Asset Management. One Raffles Place Tower 2 also achieved ~80% occupancy as of 4Q13.

Kenneth Ng, CFA, CIMB:

Office properties continue to show positive rental reversions and look set for a stronger 2014. Retail rents and retail sales have peaked and barely generate
2-3% yoy growth. Hotel data points look mixed but there are some signs that RevPARs may have bottomed.

The best performer for hotels continues to be UOL, with its new 4-star Park Royal at Pickering uniquely positioned to capture both corporate and leisure demand from other hotels.

We are most positive on the office segment as Grade-A rents have moved above S$9.50 psf in 4Q13 while the average occupancy rate has stabilised above 96%. We believe the oversupply seen during the past few years has been largely digested. With a low supply of prime-grade office (c.0.8m sf a year) over the next three years, we see Grade A rents rising 8% in 2014 and accelerating in 2015.

This has pushed up the risk of REITs making non-accretive acquisitions. More REITs have highlighted the difficulty of choosing between expensive acquisitions and no growth.

More REITs are borrowing cheaply (e.g. from Singapore) to finance acquisitions in countries with higher interest rates (e.g. Australia).

Though such an approach may boost portfolio yields in the near term, these acquisitions could elevate the mismatch risks such as 1) foreign currency risks, 2) country risks and 3) rising financing costs if interest rates in Singapore begin to rise.

Alan Cheong, Senior Director, Savills Research:

Moving into 2014, Singapore's economic outlook remains positive and will benefit from the improving external economic conditions in the US, Europe and China. The future supply pipeline of CBD Grade A office space remains relatively limited in 2014, with only about 1.2 million sq ft from CapitaGreen on Market Street and South Beach Tower on Beach Road being scheduled for completion by year’s end.

Therefore, there are very few landlords holding new supply of CBD Grade A office space, while older stock in Raffles Place, Shenton Way, Tanjong Pagar and City Hall are enjoying low vacancy rates. This has encouraged landlords to hold up rents. On the demand side, the hiring outlook remains uncertain over the next half-year and companies will continue to be conservative in their expansion plans according to the latest surveys.

Therefore, we expect the office leasing market to be dominated by small lettings, with tenants holding the negotiating power, as there are plenty of options from pockets of space in various buildings. Savills expects the recovery phase to continue over the coming quarters, with moderate rental growth in the CBD market.

The strata office market will remain healthy as there are end users and more seasoned investors who still prefer this sector, and by and large do not seem to be affected by the total debt servicing ratio framework. In view of the more positive outlook for the office rental market, we may also see a few more office investment deals. 

However, the pricing gap between buyers and sellers has widened and yields have compressed, and as such, transaction activity in 2014 will be most likely be limited due to the tightly held stocks and the lack of available investment opportunities. The growth in capital values is therefore expected to be modest.

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