Target Price S$2.15
An unprecedented supply of new business-park space is anticipated in the next four years. While there could be some pressure on AREIT’s business parks, we believe fears may have been overdone.
We maintain our estimates and DDM target price (discount rate 8.6%) but downgrade AREIT to Neutral from Outperform in view of limited catalysts. We advocate a switch to CCT at a cheaper 0.7x P/BV with similar yields (6%).
61% of supply pre-committed
We anticipate almost 7m sf of new business/science park space between 2012 and 2015. Almost 40% of this should be completed in 2012. There are some doomsday forecasts in the market, which we believe are over pessimistic. For the whole 7m sf of new supply, pre-commitment is 61%. For the 2.8m sf of new space completing in 2012, 68.5% has been pre-committed.
Demand looks positive, still
Net formation of companies that are likely to take up space at business/science parks (manufacturing information & communication, financial & insurance, professional scientific & technical activities, and arts & entertainment) is still positive, auguring well for take-up of business-park space.
Low rents of single-user and BTS buildings to offer buffer
AREIT’s fairly high weighted average rent of S$4.22 is skewed by unusually high rents from its Telepark data centre which has high specifications. If we exclude this, rents for its single-user space would range between S$1.25 and S$2.39psf; multi-user space between S$1.83 and S$3.85psf. On a weighted average basis, gross income from buildings with average rents below S$2.75psf contributed 40% to its gross income in FY11. We believe the pockets of low-based rents in its portfolio provide a safety net for possible negative rental reversions.
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1. BACKGROUND
1.1 Largest REIT owner of business-park space AREIT owns 4.8m sf (GFA) of completed business and science park space and has the largest exposure to this segment among its REIT peers. Its business parks constituted 24% of Singapore’s business-park stock (15.2m sf) as at Dec 11.
Business parks contributed a rather high 29% to AREIT’s FY11 net property income. AREIT’s Business/Science Park assets are fairly evenly spread out over Singapore, though income contributions are dominated by assets in the east (43%).
AREIT’s net property income by asset type in FY11:
Logistic 26%, Warehouse Retail 3%, Business Park 29%, High Tech 24%, Light Ind 18%
2. OUTLOOK
2.1 Distinction between business and science parks
There are three major clusters of business parks and two science parks in Singapore. The business parks are Changi Business Park (CBP) located in the east, International Business Park (IBP) located in the west, and Mapletree Business City (MBC) also in the west. The two Science Parks are Singapore Science Park in the west and one-North in the central region. One-North encompasses CleanTech Park, Fusionopolis, Biopolis and Mediapolis.
With the exception of Mapletree Business City (MBC) which had a change of zoning from industrial use, the other business/science parks were planned and developed by JTC, the public industrial landlord and regulatory authority.
CBP and IBP were developed “to address the needs of emerging industries in technology and value-added knowledge-based activities” while the two Science Parks were targeted at R&D and high technology in the biomedical sciences, infocomm technology (ICT) and media industries. In terms of building specifications, science parks typically have higher specifications catering to niche industries, while business parks tend to be more generic.
2.2 Changi Business Park in favour
In 2003, occupancy in eastern business parks (primarily CBP) surpassed occupancy in the west and central regions. The few quarters during which occupancy in the east dipped below elsewhere coincided with new supply. However, the recovery was also fairly quick.
From our industry checks, the preference for CBP is attributed to its smaller supply, proximity to Changi Airport and supposed keen promotion by EDB. The preference is indicated by its more expensive pricing. Industry players said cap rates for CBP range from low to mid-6%, in line with science parks which have even higher specifications. In contrast, IBP appears to be a poorer cousin with cap rates of mid- to high 6%. In AREIT’s portfolio, rents of CBP (average S$3.00psf in FY11) were 24% higher than IBP (average S$2.42psf in FY11).
2.3 Should we be worried about a supply glut?
Some 7m sf of business/science-park space could enter the market between 2012 and 2015. Almost 40% of this new supply is due for completion in 2012. Although there are some doomsday forecasts in the market, we believe these are over pessimistic. Pre-commitments for the new projects are stronger than anticipated. For the whole 7m sf of new supply, pre-commitment is 61%. For the 2.8m sf of new space completing in 2012, 68.5% has been pre-committed.
Notably, the largest development due to be completed this year, One@Changi City, is already 80% pre-committed and anchored by Credit Suisse. Its smaller neighbour UE Biz Hub East, also completing this year, is 50% pre-committed and anchored by CISCO. Pre-committed rentals are S$3.50-4.00psf.
Unlike its office and retail peers, industrial space and in particular built-to-suit business parks tend to have pre-committed tenants even before construction. This greatly reduces the uncertainty of filling up the new supply.
2.4 Indicative demand still strong
We look at the net formation of companies in Singapore since 2005, specifically industries that are likely to take up business/science park space. These include Manufacturing, Information and Communication, Financial & Insurance, Professional Scientific and Technical Activities, and Arts & Entertainment. Even during the negative net formation of manufacturing firms in 2009, other demand sources remained in positive territory. Demand from Arts and Entertainment, usually unnoticed, could gather pace as more global film and animation companies such as Lucas Films gradually cluster in Mediapolis when it is completed in phases.
3. RISKS
3.1 Low-based rents for single-user and BTS projects to offer buffer
In recent years, AREIT’s Business/Science Park segment has been profiting from sharply higher office rents when some industries moved their non-core operations out of the CBD into business parks. Double-digit rental reversions over several quarters have jacked up average rents for its business parks to a high of S$4.50. However, as office rents have abated from 2009, and new business-park supply enters the market amid global economic uncertainties, we believe market rates will continue to soften. To date, average market rents have declined about 14% from their last high of S$4.50.
AREIT’s gross rentals are partly skewed by high rents for its Telepark (S$5.56psf), a data centre with higher specifications than the typical business park. If we exclude this, its single-user space commands S$1.25-2.39psf; and multi-user space S$1.83-3.85psf. The high end of AREIT’s multi-user rents is already in line with the current market average of S$3.86psf. This could cap rental reversions particularly for its multi-user business-park space.
From a different perspective, AREIT’s single-user business parks are almost 50% below current market levels at an average S$2psf. Conversion to multi-user space is likely to yield upside, in our view. Additionally, some of AREIT’s properties, though classified as multi-user space, have been partially built to suit anchor tenants (e.g. 1, 3 and 5 Changi Business Crescent for Citibank) and currently fetch lower rents than the typical multi-user space. Anchor tenants for built-to-suit pay rents more in line with single-user buildings (average S$2psf). On a weighted average basis, gross income from buildings with average rents below S$2.75psf contributed 40% to AREIT’s gross income in FY11. We believe the pockets of low-based rents in AREIT’s portfolio provide a safety net for possible negative rental reversions.
3.2 Downside risk under 6% of property income
AREIT has well-spread-out lease expiries. As at 31 Dec 11, only 14.5% of its leases (on property income) will be due to expire in FY13. Of this, only 38.4% could be attributed to business parks. Collectively, any risks to business-park rents would only affect less than 6% of its property income.
3.3 How low can occupancy get?
Based on URA and industry data on upcoming supply, and their known pre-commitment levels, and further assuming a 10% attrition of current demand (i.e. non-renewal of existing space), islandwide occupancy of business parks could decline to 79.4% in 2012 and further to 78.2% in 2013, in our estimation. As AREIT’s business-park occupancy is always above that of the market, we assume it will continue to outperform by 11bp (FY11 level). This would bring its occupancy down to 90% in 2012 and 88.8% in 2013. If we remove our attrition assumption, occupancy would be slightly higher at 91.1% and 90.5% respectively.
4. VALUATION AND RECOMMENDATION
1 Downgrade to Neutral We take a more positive view of AREIT as we anticipate actual take-up of new supply to be higher than pre-commitment levels. Indicative rents for pre-committed space are also above our current assumption for renewal rents. Hence, we maintain our rent and occupancy forecasts for AREIT’s portfolio.
We continue to like AREIT’s active management of its assets and believe it is well positioned to tide over the difficult times. Nonetheless, after a good YTD performance, we believe it is fully valued. We make no changes to our estimates or DDM target price of S$2.15 (discount rate 8.6%) but downgrade it to Neutral in view of limited catalysts. AREIT trades at 1.16x P/BV and offers a prospective yield of 6.6%. We advocate a switch to CCT at a cheaper 0.7x P/BV with similar yields (6%).
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