Sustaining positive rental reversion. K-REIT continued to benefit from positive rental reversion with average portfolio gross rental rates increasing 0.9% qoq to S$8.13psf (including impact of income support from One Raffles Quay). Growth was primarily driven by Prudential Tower where revenue contribution increased by 15.5% qoq to S$3.1m. Occupancy for its buildings was relatively unchanged compared to the last quarter.
Reducing expenses. Property tax was reduced by 41.2% qoq to S$1.0m due to lower annual value as assessed by the IRAS. Other property expenses declined 17.6% qoq to S$1.2m due to efforts to rein marketing expenses.
Sustainable earnings. K-REIT’s weighted average lease term to expiry is 5.4 years on a portfolio basis. Volatility in office rentals has reduced and the pace of correction has slowed. Only 5.4% of portfolio NLA is up for renewal in 2H09. Management is confident of retaining these tenants and expect average portfolio gross rental rates to maintain at above S$8psf.
Minimal refinancing risk. Gearing was low at 27.6% as at Jun 09. There is minimal refinancing risk as its S$391m unsecured floating rate loan will only mature in Mar 2011.
According to CB Richard Ellis, average prime and Grade A monthly rents declined by 18.2% and 17.5% qoq to S$8.60psf and S$10.15psf, respectively. Take-up is likely to remain in the negative territory in 2H09 as there is usually a time lag between retrenchment exercises and the release of excess office space. However, the pace of rental decline has slowed due to improved sentiments and stabilisation in the economy.
We continue to expect rents for Grade A office space to correct two-thirds from the peak to S$6psf due to supply coming on-stream, especially in 2010. We have assumed portfolio occupancy tapering off from current 94.9% to 86% by 3Q10. We have raised our FY09 and FY10 DPU forecasts by 9.3% and 11.4% to 9.4 cents and 7.8 cents respectively.
Maintain BUY. Our target price of S$1.29 is based on a Dividend Discount Model (required rate of return: 8.25%, growth: 2.5%). We have applied a higher beta of 1.1x due to the lack of liquidity for the stock.
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