EUR 850.00 For Business Accounts Only

Morningstar | CCT’s 2Q in Line; FVE Raised; Acquisition of MAC and Asset Enhancement Underpins Mid-Term Growth

We increased CapitaLand Commercial Trust’s, or CCT’s, fair value estimate to SGD 1.82 per unit (from SGD 1.76) because we factored in higher rental income for the trust mainly driven by the acquisition of a 94.9% stake in Main Airport Center, or MAC, in Frankfurt, Germany and the leasing of 21 Collyer Quay to WeWork, a coworking space operator, for seven years from second-quarter 2021. We have also factored in the refurbishment of Six Battery Road and 21 Collyer Quay that will cost SGD 35 million and SGD 45 million, respectively. The returns from these two asset-enhancement initiatives are expected to be about 8% to 9%. Our narrow economic moat and stable moat trend ratings remain unchanged. We think the units are overvalued at the current price and future growth will mainly be driven by the acquisition of Gallileo (in second-quarter 2018) and MAC (expected to be completed in September 2019), and the development of CapitaSpring, due to be completed by first-half 2021.

CCT’s second-quarter 2019 results were in line with expectations. Net property income increased by 0.8% year over year to SGD 78.4 million, on the back of a 3.0% year-over-year increase in revenue to SGD 101 million. Distribution per unit increased by 1.9% year over year to SGD 0.022. The higher net property income was mainly driven by higher contributions from Asia Square Tower 2, or AST2, Capital Tower, 21 Collyer Quay and Gallileo, while partly offset by a lower contribution from Six Battery Road and Bugis Village.

The trust announced it will acquire a 94.9% stake in MAC with a net lettable area of 60,200 square meters for EUR 251.5 million, or SGD 387.1 million. The freehold multi-tenant office building comprising 11 floors and two basement levels is in the vicinity of Frankfurt Airport in Germany and is 11-20 minutes away from the city center by train or car. This acquisition is subject to unitholders’ approval and may be wholly funded by debt or through a combination of debt and equity. We currently assume it will be funded predominantly by debt as financing costs in Germany are low at about 1% and it provides a natural hedge for the trust against any currency headwinds. MAC is expected to generate a net property income yield of 4% based on the current 90% occupancy. Key tenants include IQVIA, Dell and Lufthansa Miles and More. We view this acquisition positively because: 1) it is distribution per unit, or DPU, accretive to unitholders; 2) it expands the trust’s portfolio in Frankfurt following its acquisition of Gallileo; and 3) the trust will benefit from longer leases since leases in Germany are typically about five to seven years as opposed to a three-year lease in Singapore.

The trust has announced it will be leasing 21 Collyer Quay to WeWork and this will be its largest workspace in Singapore. After HSBC vacates the building in April 2020, the trust will undergo an asset enhancement initiative on the building from second-quarter 2020 to fourth-quarter 2020, costing SGD 45 million. We expect the trust should be able to at least generate similar gross revenue from this lease as it does from HSBC currently, with rental escalation included in the lease. The trust has also announced it will undergo an asset enhancement initiative on Six Battery Road from first-quarter 2020 to third-quarter 2021, costing 35 million. There will be new food and beverage units on the ground floor, along with a new building facade. The asset enhancement will be done in phases to minimize the disruption to its anchor tenant, Standard Chartered. Standard Chartered will continue to lease the office space of this building.

Occupancy rates remained largely stable at most of its properties except for a decrease at One George Street, Six Battery Road and AST2; which was offset by a slight increase at CapitaGreen, resulting in average occupancy rate for its portfolio to decline to 98.6% in second-quarter 2019 from 99.1% at the end of first-quarter 2019. Three out of the eight properties that it owns recorded 100% occupancy, which includes CapitaGreen, 21 Collyer Quay and Gallileo. We expect occupancy rates to remain stable with limited upside because most of their properties are at almost 100% occupancy rates. New leases in second-quarter 2019 was largely from the banking, business consultancy, IT, media and telecommunications, retail products and services sectors.

The average grade A office monthly rental rate in second-quarter 2019 continued to increase to SGD 11.30 per square feet after hitting a bottom of SGD 8.95 in first-half 2017. This supports our view that office rental rates troughed in 2017 and will recover in the next few years. This is supported by improving demand and normalized supply for office space from 2019 to 2021 after a big increase in net supply in 2016 and 2017. It is expected that only about 0.7 million square feet on average will be added every year from 2019 to 2021, which is close to the long-term historical average of 0.8 million square feet of annual net supply additions. For the remainder of the leases that are expiring in 2019, the average rental rate is SGD 10.35 per square feet, which is below the market rental rate of SGD 11.30 per square feet in second-quarter 2019. This will support near-term rental revision during 2019 in our view. In the medium term, we expect a large increase in rental revision over 2020 because the average rents for leases that expire then are significantly below current market rents. However, we could see some downside risks in rents in 2022 because a huge supply of 1.8 million square feet is expected to be completed then.