Saturday, September 01, 2007

Office REITs: CapitaCommercial Trust & K-REIT Asia


This research note is the second part of a series on commercial REITs listed in Singapore (see here for 1st part). It is about the two office-sector REITs, CapitaCommercial Trust and K-REIT Asia. Both have the vast majority their assets housed in Singapore, although K-REIT is actively seeking acquisitions in the Asian region, and CapitaCom has stakes in Malaysian real estate related assets.

The charts below give us an idea of how the respective REITs have performed in the stock market.

Economic Conditions

The main properties under the management of K-REIT are

  • Prudential Tower Property;
  • Keppel Towers and GE Tower and
  • Bugis Junction Towers

Meanwhile the main properties under the management of CapitalCommercial are

  • Capital Tower
  • 6 Battery Road
  • Starhub Centre
  • 60% interest in Raffles City

Which together account for 82.3% of the gross revenues of the REIT.

The rental rates and other income of REITs thus depend largely on the performance of Singapore office rental market as a whole.

A recent Colliers report on the Singapore office sector records a “severe supply crunch” in 2Q07, felt most acutely for Grade A office space, which is primarily the market in which the 2 REITs participate in. Buoyed by the broader growth of the Singapore economy, there has been a surge in demand for office space in Singapore and relative lack of supply has seen rental rates rise. The government has taken steps to ease the supply crunch, with LKY expressing concern that over-inflation in office rates would threaten Singapore’s economic competitiveness. Nevertheless, office rates are expected to remain robust in the coming quarters and the longer term.

This analysis by Colliers is corroborated by other property players like CB Richard Ellis, and the optimism expressed in the financial reports by both REITs is not in doubt. Operating conditions are favourable and will be expected to remain so for both CapitaCom and K-REIT

Financial & Profitability Analysis

The table shows some key comparative ratios of the two REITs.

We can see that CapitaCom is much larger that K-REIT, by several times. Both REITs are similarly leveraged at around 27-29% of total assets.

However, in terms of profitability we see that the operating and net margins of CapitaCom are significantly higher than K-REIT by about 6 percentage points for both. This translates into a higher return on shareholders equity, 3.21% to 3.08%.

Cash flow quality is also slightly better for CapitaCom.

An interesting thing to note is that the revenue/assets for these office REITs is significantly lower as a group than the revenue/assets for the retail REITs, which average around 8%.

Valuation & Conclusions

As we can see CapitaCom is trading at a better valuation than K-REIT, it has a lower P/B and higher payout yield based on latest share prices. The profitability analysis reveals that CapitaCom is operating slightly more efficiently than K-REIT.

If I had to choose between the two, I would definitely choose CapitaCom over K-REIT. However both are trading at relatively low yields compared to other trusts like the retail trusts and the shipping trusts. An investor would have to be very optimistic that the expected economic growth is going to result in significant rental increases, in order to justify current valuations in the market.

Note: See also this piece on the healthcare REITs.

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