Singapore Office Sector (DMG)

The recent market sell-down could be a harbinger of things to come. There are visible signs of a global economic slowdown and Singapore looks like it could be heading into another recession. With ample new office supply and looming secondary supply, we are of the view that office rents have peaked, with mounting downside risks. We advise investors to switch out of the office sector and switch to developers with diversified exposures.

Jittery markets a harbinger of things to come?

The Eurozone debt woes have continued to plague on, with some economists citing that the risks that the bloc may eventually split have elevated. Things are not looking rosy in the U.S. either, as it gets mired in its own debt crisis. As for Singapore, the government has also cut its 2011 GDP forecast from 5-7% growth to 5-6%, led by a weakening manufacturing sector. Demand for office space is closely tied with business sentiments and economic confidence. It can be shown that on a historical basis, if the quarterly GDP YoY growth rates decline by more than 5 ppts over two consecutive quarters, this heralds an impending office sector downturn. In 2Q11, Singapore’s GDP grew by a mere 0.9% YoY compared to the 9.3% YoY growth for 1Q11, which may not bode well for the office sector.

Buoyant office leasing activities are over

According to Jones Lang Lasalle, average prime office rents surged 31% to $10.15 psf in 2Q11 from a recent trough of $7.75 psf in 1Q10. Much of the leasing activities came in a busy 12-month period which saw bulk pre-commitments from major financial institutions and MNCs for space at the new International Grade A developments such as MBFC and Ocean Financial Centre. The strong office demand came at a time when the Singapore economy rebounded strongly, coinciding with a tight office market as the new developments were still under construction. However, with most of the bulk leases already signed, momentum started to wane in 2Q11. We think that with the looming economic headwinds, office rents have already peaked.

Older developments could lead the downturn

While Singapore is likely to remain a desired destination for international companies as occupation costs remain at a significant discount to our closest competitor Hong Kong, prime Grade A rents could see a correction of about 10% by end 2012 to $9.60 psf, and $12.15 psf for the International Grade A category. Prime Grade B buildings may see greater downside pressure, considering increased competition from alternative supply, such as business parks, secondary space, and perhaps even the return of “shadow space”.

Downgrading office landlords, prefer diversified developers

We are downgrading Singapore Land to SELL (TP: $4.89), and would avoid other office-biased landlords, such as OUE (unrated). At this juncture, we prefer developers with more business diversification. We are maintaining our BUY calls on CapitaLand (TP: $3.56) and Keppel Land (TP: $4.05) although on lower valuations due to their office exposures. We are downgrading City Developments Limited to a HOLD on valuation grounds (TP: $11.05), due mainly to a lower M&C share price and a weaker Pound Sterling.