K-REIT Asia - Lower gearing, higher upside

Credit crunch significantly abated with improved availability of bank loans and reopening of CMBS market. K-REIT has been conservative in valuing its assets and has lowest gearing among office REITs.

Credit crunch has abated. Availability of funding via bank loans has improved significantly. There is a slight improvement in the credit spread that banks charge, although the quantum is not obvious in management's opinion. Management sees an advantage in the longer tenures of 5-7 years provided by commercial mortgage-backed securities (CMBS). Cost of borrowings for long-dated CMBS is not as prohibitive, compared with bank loans, as the yield curve is not as steep. K-REIT has a S$190m CMBS that matures in May 2011.

Conservative in valuing assets. K-REIT revalues its investment properties once a year and the next valuation will be conducted in Dec 09. The company has been conservative in valuing its assets and usually marks prices at the lower end of the market range. It values Prudential Tower at S$2,066psf, Keppel & GE Towers at S$1,347psf, Bugis Junction Towers at S$1,265psf and One Raffles Quay at S$2,213psf. The risk of severe markdowns in asset values is quite low, especially given the recent rebound in transaction prices for strata office space.

K-REIT has the lowest gearing of 27.6% among office REITs (CapitaCommercial Trust: 30.7% post-rights issue, Suntec REIT: 34.4%). Financial risk is low as the next refinancing is an unsecured floating rate loan of S$391m from Keppel Corporation due Mar 2011.

We expect rentals for Grade A office space within Raffles Place to correct two-thirds from the peak to S$6psf pm. We have, however, lifted our base case assumption for office occupancy from 82% to 86% due to an improvement in the macroeconomic outlook.

Maintain BUY with target price at S$1.16, based on a dividend discount model (required rate of return: 7.7%, growth: 2.5%). Share prices for office REITs CapitaCommercial Trust (NOT RATED/S$0.995/Fair: S$0.82) and Suntec REIT (SELL/S$1.04/Fair: S$0.83) were 21.3% and 25.3% above our fair value respectively. Thus, K-REIT could also trade above our target price of S$1.16.

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