Singapore office market — it ain’t over till the fat lady sings
By Alan Cheong
/ Savills |
These are strange days for the commercial real estate market in Singapore. On the one hand, rents have been falling for the past two years and are expected to continue coming off significantly in 2017. On the other, capital values of Grade A CBD office buildings are not merely holding firm but are, in fact, rising. This behaviour al mishmash between the rental and capital markets is a result of the different objectives of the market players. Rents have been declining because tenants are reeling from the global economic malaise, or, like financial institutions, facing structural issues in their business models. Thus, they are giving up space. The increasing supply of new office buildings does not help on that front.
Investors, particularly institutions and local developers, are aghast at recently transacted prices as these imply a significant degree of yield compression, not only using current passing rents, but even more so when leases are due for renewal and/or review. Yet judging from four recent transactions, it appears that buyers are undaunted by this fundamental measure of return.
For example, the transactions of the the Straits Trading Building and 110 Robinson Road reported net yields of 2.8% (gross at 3.5%) and about 1% respectively. In comparison, in 3Q2016, the net yields from Savills’ basket of Grade A office buildings based on valuation prices was 3.4%.
If we include vacant land, in early November, IOI Properties of Malaysia submitted a bid of $2.57 billion for a piece of prime land in the CBD. With the imputed construction and ancillary costs, the breakeven price worked out to about $3,000 psf based on a net lettable area (NLA) of 1.29 million sq ft — higher than that for the adjacent site, Asia Square Tower 1, which was sold to the Qatar Investment Authority in June this year for $2,674 psf.
Why have investors shell out hundreds to billions of dollars to acquire assets at prices above the pre vious high water mark, and more crucially, buying when rents, and thus yields, are expected to compress further in the coming year?
Source: Savills Research & Consultancy
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There are a couple of possible reasons for this economically non-rational behaviour. One is that office buildings available for sale in the CBD are few and far between. Also, vendors are keeping their asking prices high and hardly budging. Secondly, those paying record prices in the current market are mostly non-private- equity buyers. This is because at current prices, given the stage of the lease reversion cycle and the risks of further interest rate increases, these institutions find it difficult to make out a case for investing. What is left are sovereign wealth funds and ultra-high net- worth individuals who purchase for the long term. When these two reasons come head to head, prices are ratcheted, upsetting the normal tripartite relationship between rents, interest rate and capital values.
These buyers are motivated to take a position in Singapore to diversify from non-core (such as developmental properties) to core holdings (like investment properties) or to de-risk politically by increasing their weighting to Singapore at the expense of their traditional markets. Will this trend continue in 2017? We believe so. Even if interest rates are bumped up a little and headwinds continue to buffet Singapore’s economy, this set of long-term buyers is quite undeterred and has additional capital waiting to be deployed not just here but also in major gateway cities.
Therefore, even though yields are compressing owing to weak rental reversions at a time when the market is facing a significant amount of new supply coming on stream, they can, in all likelihood, come down even more. Future yield compressions will come about from a combination of falling rents and rising capital values.
The risk of a sharp mean reversion to the 4%-to-5% yield levels is low because sellers have holding power and buyers have the wherewithal to pay. In fact, with noises in the market that a Trump presidency may bring about changes to the Dodd-Frank act, the surprise on rents could be on the upside, if banks, being less fettered by regulatory restrictions, start to expand again.
Source: Savills Research & Consultancy
This article appeared in The Edge Property Pullout, Issue 760 (Dec 26, 2016) of The Edge Singapore.
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