Comprehensive Suntec REIT Analysis: Financial Performance, Risks, and Investment Potential

Broker Name: OCBC Investment Research

Date of Report: 25 October 2024

Introduction

Suntec REIT, a prominent player in the Singaporean real estate market, holds a diverse portfolio of properties including some of the most significant commercial developments and shopping malls in the country. Despite robust operational trends, certain financial metrics and external factors pose challenges. This article delves into Suntec REIT’s performance, risks, and future potential.

Financial Performance

The financial performance of Suntec REIT in 3Q24 presents a mixed picture. The distribution per unit (DPU) fell by 11.9% year-on-year (YoY) to 1.58 Singapore cents. This decline was largely attributed to higher borrowing costs and the absence of capital distributions that added 0.198 Singapore cents in 3Q23. Gross revenue and net property income (NPI) for the quarter fell by 4.6% and 5.7% YoY, respectively, amounting to SGD 117.7 million and SGD 79.8 million. The drop was mainly due to lower contributions from Suntec Convention, 55 Currie Street in Adelaide, and The Minster Building in London, albeit partially offset by better performance from Suntec City’s office and mall segments.

Operational Highlights

Despite the dip in DPU, Suntec REIT reported robust rental reversions and improved occupancy rates in its Singapore office and retail portfolios. Rental reversions for the Singapore office portfolio came in at +12.9%, while Suntec City Mall saw an impressive +21.2%. Management expects retail reversions to remain within the 15%-20% range for FY24, moderating to 10%-15% in FY25. Current signing rents at Suntec City Office range between SGD 10.50 and SGD 12.00 per square foot per month (psfpm), with expiring rents in FY25 at SGD 10.05 psfpm, indicating mid-to-high single-digit rental reversions for the next fiscal year.

International Portfolio Performance

In Australia, 9M24 rental reversions were +13.3%, although current incentive levels remain high. The overall office portfolio committed occupancy rose to 95.6%, with expectations for the Minster Building in the UK to reach full occupancy by the end of FY24. Additionally, Suntec REIT managed to remove break clauses for FY25 in the UK but at the cost of providing incentives to tenants.

Balance Sheet Metrics

On the balance sheet front, Suntec REIT’s aggregate leverage ratio remained unchanged at 42.3% quarter-on-quarter (QoQ). The proportion of borrowings hedged increased by 6 percentage points (ppt) to 61%, while all-in financing costs inched up by 4 basis points to 4.06%. Management anticipates cap rates for its Australian portfolio to expand by 70-75 bps for the year-end valuation exercise, leading to approximately AUD 200 million in revaluation losses. With stable capital values in Singapore and the UK, the aggregate leverage ratio is expected to face upward pressure, potentially reaching around 43%. The management is also targeting the sale of more strata-titled units at Suntec City Office, having met 50% of its SGD 100 million target, although momentum has slowed.

ESG Performance

Suntec REIT’s ESG rating was downgraded in November 2023, primarily due to weaknesses in staff management efforts compared to peers. Key areas of concern include the absence of annual employee satisfaction surveys and apprenticeship programs. While Suntec REIT has an independent board majority, it lacks a fully independent pay committee and has limited executive pay disclosures. On the environmental front, 100% of Suntec REIT’s portfolio is certified to green building standards as of FY22, significantly higher than the industry average of 29% as of May 2023. Suntec REIT also received a 5-Star rating for the fifth consecutive year in the 2024 GRESB Real Estate Assessment.

Investment Thesis

Suntec REIT’s Singapore operations continue to gain traction, achieving robust rental reversions for both its retail and office portfolios. The convention business has also recovered faster than anticipated. However, rental reversions for Singapore office assets are likely to moderate, and uncertainties persist regarding the long-term impact of work-from-home trends. In Australia and the UK, office portfolios have been impacted by impairments to asset valuations and pressure on occupancy rates. Additional risks include currency fluctuations, a relatively high aggregate leverage ratio, and a low interest coverage ratio (ICR) compared to peers, along with slower-than-expected momentum in asset divestments.

Investment Summary

Suntec REIT’s 3Q24 business update reflected another quarter of divergence between solid operational trends and weak DPU performance due to borrowing cost pressures. The REIT’s gross revenue and NPI fell by 4.6% and 5.7% YoY, respectively. Joint venture income rose by 5.0% to SGD 25.0 million. Despite these challenges, Suntec REIT achieved robust rental reversions and improved occupancy rates across its portfolios in Singapore and Australia. The REIT also managed to remove break clauses in the UK, although incentives had to be provided to tenants.

Potential Catalysts and Risks

Potential Catalysts

• Stronger-than-expected recovery in office and retail rents.
• DPU accretive acquisitions.
• Better-than-expected momentum in footfall and tenants’ sales for Suntec City Mall.

Investment Risks

• A slowdown in macroeconomic conditions may dampen consumer and business sentiment.
• A rising interest rate environment could raise borrowing costs for Suntec REIT.
• Non-renewal of leases by key tenants.

Valuation Analysis

For FY24E and FY25E, Suntec REIT’s DPU yield is projected at 4.9% and 5.3%, respectively, with a Price/NAV ratio of 0.6x for both years. The return on equity (ROE) is estimated at 2.9% and 3.0%, while the gearing ratio is expected to slightly decrease from 42.3% in FY23 to 41.5% in FY25.

Conclusion

Suntec REIT remains a significant player in the Singaporean real estate market, with a diverse and strategically located portfolio. Despite robust operational metrics, financial challenges such as high borrowing costs and leverage ratios persist. The REIT’s commitment to ESG practices and the potential for rental reversions and improved occupancy rates in key markets provide a balanced outlook. Investors should consider both the potential catalysts and inherent risks when evaluating Suntec REIT as an investment opportunity.