Suntec REIT - Fairly valued - downgrade to HOLD

Office rents down 35% from peak. CB Richard Ellis data showed that both prime and Grade A monthly office rents have fallen about 35% from the highs of this cycle achieved in 2Q-3Q08. 1Q09 rents of S$12.30 psf per month for Grade A (versus S$18.80 psf pm in 3Q08) and S$10.50 psf pm for prime rents (versus S$16.10 psf pm in 3Q08) have taken the market back to 2Q07 levels. Meanwhile, the Business Times reported that a 16- storey freehold office block in the CBD has been sold by a UK fund. The Parakou Building was sold for about S$81.38m or S$1280 psf of net lettable area. The transaction is at a 36% discount to the S$128m the seller paid for the property two years ago. This is the first major office transaction after a fairly subdued 4Q08-1Q09.

We maintain our stance on office. The market data jibes with Suntec, which reported achieved rents of S$9.96 psf pm for Suntec City Office in 1Q09. In 2Q08, the manager had disclosed achieved rents in the range of S$12-15. At the results briefing, the manager had said that maintaining occupancy above the 90% level is a key priority. Negative drivers for office rents and capital values still persist, in our view: 1) excess capacity concerns; which are exacerbated by 2) a questionable demand outlook as companies rationalize their need for both existing space and planned expansions. As such, we maintain our forecast of continued rent declines for Suntec's office portfolio over FY09.

Capital value decline may drive recapitalization. With the successful refinancing of S$825m in loans maturing this year, Suntec's next refinancing requirement arises only in FY11. Our attention is on capital values - as independent valuations catch up with the market, we expect asset values to fall across the sector - increasing gearing levels. Lender and market appetite for leverage is low and we believe more S-REIT managers may launch equity issues to recapitalize REIT balance sheets.

Fairly valued. Our valuation for Suntec recognizes the need for correcting that implicit under-capitalization through additional equity - we price in an equity issue of S$500m at an issue price of S$0.70 (up from S$0.60 previously due to the recent price run up). This takes our fair value estimate for Suntec to S$0.84 (from S$0.80 previously) - or a 7% discount to our SOTP value of S$0.91. Suntec's price has increased 32% since our last report just three weeks ago. Downgrade to HOLD on valuation grounds.

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