The Business Times reported that Singapore-listed companies’ office real estate investment trusts (S-Reits) have the potential to be the “dark horses” on the local bourse next year as they are more sensitive to interest rate cuts compared to other sub-sectors, analysts say. Positive business sentiment, easing debt, and a continuing trend toward work-from-office could buoy office S-Reits, whose valuations have lagged behind their counterparts on the bourse.
Office S-Reits are trading at about a 50% discount to their book values on average, compared to the overall S-Reit sector which is trading at about a 20% discount. Already, there are signs that interest rate cuts can have an outsized impact on office REITs. Following the first interest rate cut by the US Federal Reserve in more than four years on Sep 18, the three US office S-Reits—Keppel Pacific Oak US Reit (Kore), Manulife US Reit, and Prime US Reit—led the gainers among the constituents in the iEdge S-Reit Index for Q3.
Derek Tan, the head of regional property research at DBS Research, told The Business Times that commercial S-Reits, which include office Reits, have the potential to be dark horses next year as concerns over their relatively higher leverage ratios ease with rate cuts. “Their sensitivity to interest rates is higher compared to other sub-sectors. If we are on a sustained downtrend, the ability to surprise is certainly higher,” said Tan.
In the case of US office S-Reits, specifically, analysts said that the jump in their share prices following rate cuts was due to their lower share price compared to other office S-Reits. The price declines in S-Reits with office assets in Singapore have been smaller compared to US office S-Reits. Therefore, when the recovery comes, the share price upside is not as sharp, said Carmen Lee, head of OCBC Investment Research.
Lower interest rates can also spur hiring, boosting demand for office space. “As rates are lowered, we expect more companies to invest in growing and expanding their business—hiring more employees and taking up more office space to house these employees,” said Xavier Lee, an equity research analyst with Morningstar.
However, Morningstar’s Lee said that a meaningful impact on office demand would require further rate cuts to spur economic activity and boost business sentiment. Given the limited supply of office space in the central business district, office rents are expected to “accelerate” in 2025 on the back of improved office leasing demand, he said.
Office Reits that stand to benefit from the growth are Keppel Reit, CapitaLand Integrated Commercial Trust (CICT), and Suntec Reit. Several analysts also felt that Amazon’s move to recall its workers to the office will have a knock-on effect on other companies, improving demand for office space. On Sep 16, the tech giant announced that its employees will have to work from the office five days a week, up from three currently, starting next year. Other big companies, such as consultancy McKinsey, are also rethinking their remote working policies.
OCBC Investment Research’s Lee said that it is “highly likely” that companies may request workers to work from the office more frequently, which should help with office occupancy. For US office S-Reits, in particular, the policy change by Amazon marks an “incremental positive” as office occupancy rates in the US could improve, according to DBS Research. The research house expects the risk for US office Reits—which have seen their occupancy rates dip to 80% recently—to lower with more staff returning to the office. It named Kore and Prime, which are leading the recovery among US office S-Reits, as its preferred Reits for investors who are looking to participate early in the recovery of the office sector.
However, Morningstar analyst Suryansh Sharma was less optimistic. He believed that beyond Amazon, more companies would have to mandate a return to office before there is a material impact on office Reit fundamentals. Overall, analysts said that office S-Reits remain undervalued compared to other sub-sectors and warned investors to watch out for headwinds.
Darren Chan, a senior research analyst at Phillip Securities Research, expects rental reversions for the sector to remain positive going forward. However, it is likely to fall from around 10% currently to the low or mid-single digits as demand for office space will not be high enough to absorb the new supply of office space. Chan added that the brokerage prefers other sub-sectors, such as retail, as it believes hurdles remain for office S-Reits.
A common challenge that office S-Reits face is an economic downturn, which analysts said could affect business sentiment. Slower leasing momentum and lower occupancy or tenant defaults could also impact office S-Reits, they warned. Lee of OCBC Investment Research said that bigger Reits with diversified holdings across several geographical locations remain preferred to reduce over-exposure to one asset or country.
Given the more dovish stance on interest rates moving towards FY25, as well as improving economic fundamentals of the office sector, we maintain an ACCUMULATE rating on the Singapore office REITs, such as Keppel REIT (6% yield, 0.7x price to book), CICT (5% yield, 1x book), and Suntec REIT (6% yield, 0.6x book).
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