Starhill Global REIT - Fairly valued

In past notes we have flagged that while Starhill Global REIT’s 1Q09 results were broadly in line with our expectations, the weakening economic environment is likely to bring lower retail and office rents in 2H09F, and heightened occupancy risk, as new supply comes on stream. According to Jones Lang LaSalle, some 2.5mn sf of new retail supply is due for completion in 2009F and 2.3mn sf in 2010F.

The distribution of new supply is relatively evenly spread over the next two years, with 33.4% scheduled to be completed in the prime shopping districts, 33.8% in secondary shopping districts, and 32.9% in suburban locations. Approximately 1.4mn sf of new and refurbished malls will be opened in Orchard in 2H09F, including ION Orchard (663,000 sf), 313 Somerset (294,000sf), Orchard Central (250,000sf) and Meritus Mandarin (215,000sf), directly competing with Starhill’s prime Orchard Rd properties Wisma Atria and Ngee Ann City.

Amid rapid deterioration in the economy, we have seen a faster contraction in occupancy and greater decline in office rents than previously anticipated. According to JLL, office demand in the CBD contracted by 558,418sf, resulting in CBD vacancy rising to 6.9% in the CBD Core. In the past six quarters, net demand in the Singapore CBD has contracted by 813,008 sf, with Orchard Rd rents falling 21.6% q-q in 1Q09 and now 35.0% down from the peak, impacting reversions in the REITs office towers in Ngee Ann City. While the supply/demand outlook has deteriorated, we have maintained our office rent assumptions — rents falling by 57.0% from peak to trough — as incremental increases in vacancy are likely to have less impact on overall rents, with an improvement in the quality of stock underpinning a marginal rise in rents late in the cycle, notwithstanding higher vacancy, which is likely to be concentrated in poorer quality buildings. That said, we caution that the recovery is likely to be slower than in past cyclical corrections. Expectations of a lower growth profile in rents, in part, are reflected in our expectations for capitalisation rates to move out by 50bps over the cycle.

We have revisited our valuation for Starhill Global REIT, rolling forward our intrinsic NAV to FY10F, from FY09. Our adjustments to earnings forecasts reflect expectations of marginally weaker office occupancy following weaker-than-expected 1Q09 demand estimates. We peg our new price target to our FY10F intrinsic value of S$0.74/unit (previously: FY09, S$0.70/unit), with the rise in NAV underpinned by a lower dilutive impact of a possible capital raising on our expectations of possible revaluation deficits. We assume circa S$115mn of new capital is raised at the current share price of S$0.73/share; previously we assumed capital was raised at S$0.47/unit, the unit price at the time. While we see inherent value in the Orchard Rd assets, valuations prompt us to cut our rating to NEUTRAL, from Buy.

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