Friday, November 30, 2012

2013 year of digestion for offices: CIMB

6 reasons why 2013 could be “not so bad”.

The Street is still largely negative on the office sector in 2013. Consensus is of the view that a slew of primary and secondary office supply could intensify the pressure on rents. But while CIMB do not see office rents improving in 2013, It retains its view that a bottoming could be in sight.

Here’s why:

1) Slower pace of headline declines. Indicators in 3Q12 had started to improve. Consultant estimates show that vacancy growth rates have decelerated with rental declines also moderating.

2) Backfilling gathering momentum. Agreed, a large part of the headline improvements is due to pre-commitments for newer premises which have resulted in the double counting of office space to be vacated. We estimate that the true vacancy rate island-wide is closer to 8% (vs. 6.5-7.5% estimated by consultants) if secondary office space due to be vacated is included, and about 10% in the core CBD. However, landlords have generally been proactive in backfilling and have been enjoying moderate success. Nearly 90% of the 129k sf space vacated by Citibank at Centennial Tower is reportedly filled, while the latest results by CCT and FCOT indicate that vacated space at One George Street and China Square is also being taken up. Most office REITs have guided that demand comprises a mix of new-to-market tenants and tenant relocations, with many of them taking up more space than before. We expect vacancy rates to remain stable and peak in 2013.

3) Redevelopments and removal of older inventory. Supply in the office sector is dynamic and cannot be viewed in a vacuum. Older inventories that cannot compete are typically removed and redeveloped.

Since 2009, we estimate that an average of 0.5m sf commercial space has been removed from the system for redevelopment. We are seeing this happening in the old CBD area (Shenton Way/Robinson Road). In 2009-10, many older buildings were converted into residential apartments. CBRE expects another 3.4k residential units to be built by 2018, on top of the 3k-3.5k units currently. Outside the CBD, private
developers have equally been taking advantage of low interest rates to snap up older commercial buildings for redevelopment. Recall the recent sale of NOL Building to The Fragrance Group which could deplete 207k sf of office space. We expect more redevelopment to alleviate supply pressures in 2013.

4) Strong initial interest for The Metropolis; Asia Square 2 the only new Grade-A offering in 2013. Commitments for 2012 supply have reached a steady state, at around 83%. In 2013, The Metropolis (decentralised) and Asia Square 2 (New downtown) will add 1.8m sf of new office space, forming the bulk of the 2.4m sf new supply. While The Metropolis has yet to receive formal pre-commitments, media reports suggest that take-up could be strong with potential demand from Shell (>110k sf), NOL (>100k sf), GlaxoSmithKline (>60k sf), Singapore Exchange (back office) and Proctor & Gamble (>200k sf). We believe many of these tenants could end up taking up more space than what they will be giving up. Interestingly, CBRE noted in its 3Q12 report that companies were starting to take advantage of lower occupancy costs to consolidate or incrementally expand their operations. Asia Square 2 will be the only new Grade-A offering in 2013 and we remain optimistic that take-up will be better than expected. Older Grade-B/decentralised office space, on the other hand, could succumb to further demand and rental
pressure on tenant migration.

5) Demand drivers to evolve. Legal, commodity, manufacturing, shipping and IT are some of the non-financial services sectors driving office demand currently. Proximity to ASEAN countries, a tax-friendly
regime and strong soft/hard infrastructure remain Singapore’s biggest attractions. Office demand in 2013 looks set to stem from a more diversified group of takers.

In particular, more law firms are expected to set up shop in Singapore, as part of the government’s efforts to promote Singapore as a legal hub. The Ministry of Law recently threw open the doors for a second round of licences to be issued under its Qualifying Foreign Law Practice (QFLP) scheme. As at 31 Aug, 23 foreign law firms had applied, including London-based Watson, Farley & Williams LLP, DLA Piper and Jones Day. If all the applicants are successful, we estimate that 350k-450k sf of incremental office demand could be generated. Office demand from European and US financial services firms has stalled. But we note that regional outfits have been expanding to gain market share as foreign incumbents in Singapore scale back on their operations. In Jul 12, the MTI announced that two eligible financial institutions will act as clearing banks for the Rmb in Singapore. This follows MAS statements that its QFB programme will be modified to encourage foreign banks to deepen their roots in Singapore, potentially
giving some QFBs an additional 25 new places of business.

6) Stable job creation. Singapore remains a full-employment economy. Despite slower growth, its economy created sufficient jobs to nudge its seasonally-adjusted unemployment rate to 1.9% in 3Q12 (average 2.0% for the past six quarters). This came amid tighter foreign manpower controls that are gradually being implemented. Service-sector employment will likely slow to 65k this year, the least in three years, accounting for 55% of all new employment in 2012 (81% in 2011 and 99% in 2010). Assuming an unchanged resident-labour participation rate and about 2% growth in the foreign workforce, our Singapore economist estimates that another 125k new jobs can be created in 2013, with the service sector accounting for roughly 80K or 65%. Hudson’s latest survey shows a modest increase in hiring expectations in 4Q12 with 35.9% of the respondents planning to increase headcount, up from 34.7% in 3Q12. Interestingly, hiring expectations by banks and financial-service companies rose from a low of 23.1% to 31.1%.

Martin Koh | 86666 944 | R020968Z
Sherry Tang | 9844 4400 | R020241C
Senior Sales Director
DTZ Debenham Tie Leung (SEA) Pte Ltd (L3006301G)

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