Refer to important disclaimers at the end of this report DBS Group Research Asian Insights Office 16 May 2017 Overall Outlook Office rents to bottom in 2017 With Marina One slated to be completed this year, we project office rents to bottom in mid or late 2017 Our base scenario assumes Grade A office rents to hit a trough at cs$850 per square foot per month (psf/mth) from S$910 psf/mth currently Not only is this reflective of the expected spike in vacancy rates in the overall Downtown Core area but is also at a market clearing level to entice a company to move into a new office given fit-out costs of S$200-250 psf/mth and peak office rents of S$1040-1140 psf/mth In our bear-case scenario, we project Grade A office rents to hit a low of S$750-800 psf/mth, which is 12-18% below current Grade A office rents of S$910 psf/mth Soft start to 2017 as expected Office rents started the year on a weak note as expected Based on CB Richard Ellis (CBRE) estimates, Grade A office rents fell 2% quarter-on-quarter (-10% year-on-year) to S$895 psf/mth after falling 2% quarter-on quarter (-13% year-on-year) in the fourth quarter of 2016 The Grade B segment also had a slow start to the year with rents dropping 1% quarter-on-quarter (-9% year-on-year) to S$725 psf/mth Grade A occupancies improved to 966% from 958% in 4Q16 and 95% in 1Q16, owing largely to pick-up in demand in the Raffles Place/New Downtown area Table 1: Office rents and occupancies Rents 1Q17 4Q16 1Q17 q-o-q y-o-y URA Office Rental Index: Central Area 1801 1686 1622-4% -10% URA Office Rental Index: Fringe Area 1406 1336 1336 0% -5% CBRE Grade A Core CBD (psf/mth) 990 910 895-2% -10% CBRE Grade B Core CBD (psf/mth) 795 735 725-1% -9% Occupancy 1Q17 4Q16 1Q17 q-o-q (bps) y-o-y (bps) URA occupancy private sector: Central 901% 880% 881% 10-204 Downtown Core URA occupancy private sector: Central 911% 871% 875% 31-369 Fringe Area CBRE Grade A 950% 958% 966% 80 160 CBRE Core CBD 951% 958% 956% -20 50 1 Weakness in office rents continues, with a bottom likely to be reached upon completion of various new office buildings from now till June 2017 Source: URA, CBRE, DBS Bank Demand Uncertain outlook for new office demand Over the past three years, employment growth in the four key sectors driving office demand (1) financial services, (2) IT and other information services, (3) legal, accounting and management services, and (4) insurance services had been healthy The average three-year compounded annual growth rate (CAGR) for the four sectors was c5% Given a slowing economy, announced job losses in the financial services industry and businesses moving out of the CBD to business parks/suburban locations, we believe the demand for new office space will be sluggish However, demand should remain positive given the still positive GDP growth In Page 1
addition, despite the negative headlines, c49,000 square metres (sqm) of space was still taken up in the Downtown Core area in 2016, with the number of people employed in the services sector growing by c44,000 in 2016 Stable pre-commitment rates for key new buildings Pre-commitment and occupancy levels for upcoming/recently completed offices were stable or have improved marginally since the end of 2016 Occupancy at Guoco Tower was stable at between 85% and 90% with occupancy at DUO Tower, which received its TOP in December, now at 475% up from its 40% pre-commitment level Meanwhile, pre-leasing at Marina One was reported to be unchanged at 60% We also understand Frasers Tower (scheduled to be completed in 2018) has achieved pre-commitment levels of 40% (including leases in advanced negotiations) As the pre-commitment and occupancies in the new buildings increase, we believe the pressure to lower rents to secure tenants will start to ease We understand the asking rents are now at S$8-9 psf/mth, compared to initial rents in the S$7 psf/mth level Supply Elevated new supply in 2017 before easing over 2018- After the completion of Guoco Tower and Duo Tower in 2016, new office supply will remain elevated in 2017 largely due to the Marina One (c19m sqft) Net supply in the downtown core region is expected to increase 6% in 2017, following the 6% increase in 2016 Supply is expected to ease thereafter with only Frasers Tower (c664k sqft) and the redevelopment of International Factors Building/Robinson Towers (c194k sqft) coming on-stream in 2018 and Funan (c664k sqft) in The next wave of supply will come around 2021 when Golden Shoe (c800k sqft) and Central Boulevard (c11m sqft) are completed Forecasts Spike in vacancy but market moves to two-tier market On the back of sluggish demand and jump in supply, we expect the Private Sector Downtown Core vacancy rate to potentially spike from 13% at the end of December 2016 to 17% in 2017 and 18% in 2018, approaching the levels seen in 2004 and surpassing the 14% vacancy level in 2010 and 2011 While the headline vacancy rate is high, the vacancy rate will be composed of two very different markets One would consist of the older buildings such as those in Shenton Way and Raffles Place where there will be a structural or persistent high vacancy potentially in excess of 20% as these buildings are unable to compete against the new buildings currently under construction or recently completed due to less efficient floor plates and modern specifications In contrast, newer buildings or those defined as Category 1 office buildings by URA will enjoy substantially lower vacancies, closer to the 10% level, as the flight to quality takes place, ie tenants seeking better-quality offices to cater to their expansion plans or consolidate their various offices into a single location According to URA, Category 1 office buildings are defined as those located in core business areas in Downtown Core and Orchard Planning Area, which are relatively modern or have been recently refurbished, command relatively high rentals, and have large floor plate sizes and gross floor areas Recovery from 2018 onwards While we expect office vacancy rates to peak in late 2017 or early 2018, with new office supply easing from 2018 onwards, we anticipate rents to start recovering as early as mid/end of 2017, as both tenants and landlords expect vacancies to potentially drop due to a fall in supply However, we expect a recovery in rents to largely occur in the premium spectrum of Grade A office space, as the older buildings at Shenton Way and Raffles Place will unlikely be able to raise rents due to their still high occupancies and uncompetitive product On that front, we expect Grade A office rents to recover from the S$850 psf/mth low in 2017 towards S$10 psf/mth by end-2018, similar to the 14% rise in office rents experienced between mid-2013 and 2015 as we approached a dearth of new supply in 2015 and demand normalises to the historical average in The projected recovery in Grade A office rents is also partially a result of the increased proportion of premium-quality office stock commanding higher office rents Page 2
Key Charts Office Sector Table 2: Office supply in the Central Business District (CBD) Office (CBD) Location Developer Estimated NLA (sqft) 2017 Property Type Marina One Marina Bay M + S 1,875,630 Leasing UIC Building Shenton Way UIC 277,540 Strata Sale Oxley Tower Robinson Road Oxley Consortium 111,710 Strata Sale Crown @ Robinson Robinson Road WyWy Developments 70,000 Strata Sale 2018 2,334,000 Redevelopment Robinson Road Tuan Sing 194,380 Strata Sale of International Factors Building and Robinson Towers Frasers Tower Cecil Street Frasers Centrepoint Limited 645,000 Leasing Funan 2020 North Bridge Road CPF Building Shenton Way Ascendas-Singbridge, Mitsui and Tokyo Tatemono 858,380 CapitaLand Mall Trust 204,000 Leasing 204,000 500,000 Leasing 500,000 1 6% increase in supply in the downtown core region in 2017, following 6% increase in 2016 2 Supply to ease over 2018-2020 3 Following the easing of supply in 2018 and, a pick-up in new CBD supply will only occur in 2020/2021 when CPF Building, Golden Shoe and Central Boulevard White site are scheduled to be completed 2021 Golden Shoe Market Street CapitaLand Commercial Trust 800,000 Leasing Central Boulevard White Site Marina Bay In bidding stage 1,070,000 Leasing 1,870,000 Source: URA, Corporate Locations, CBRE, various REITs and corporate, press reports, DBS Bank Table 3: Decentralised office supply Office (Decentralised) Location Developer Estimated NLA Property (sqft) Type 2017 Arc 380 Eastern Suburbs Tong Eng Group 103,500 Strata Sale - Jalan Besar Vision Exchange Western Suburbs 500,000 Strata Sale - Jurong 603,500 2018 Paya Lebar Central Woods Square Eastern Suburbs - Paya Lebar Northern Suburbs - Woodlands Lend Lease / ADIA 750,000 Leasing 750,000 Far East Organisation 534,500 Strata Sale 534,500 1 Over the next few years, supply of decentralised office space will be steady As a large majority of this new supply are being sold as strata units potentially for smaller users and owner occupiers, they will compete directly with CBD space 2 However, in 2018 Paya Lebar Central may pose some form of competition to CBD office space if Lend Lease/ADIA is able to position the property as a viable alternative Source: URA, Corporate Locations, CBRE, various REITs and corporate, press reports, DBS Bank Page 3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2020 2021 Industry Outlook Chart 1: Average new supply per annum over 2015- in line with average between 2010 and 2014 3,000 2,500 2,000 1,500 1,000 500 0-500 -1,000-1,500 '000 sqft Post GFC 2010-2014 average: 11m sqft Net supply: Downtown Core (LHS) Net demand: Downtown Core (LHS) CBRE Grade A office rents (RHS) S$ psf pm 2015- average: 11m sqft 200 180 160 140 120 100 80 60 40 20-1 While the headline supply is expected to be large between 2015 and, the average supply of 11m sqft pa is comparable to 2010-2014 s average of 11m sqft pa 2 Despite the large supply in 2010-2014, central area office rents still recorded positive growth Source: URA, DBS Bank Chart 2: URA rental index (central) growth vs changes in employment for financial institutions (1998 present) 70% 60% 50% 40% 30% 20% 15% 10% 1 Between 1998 and 2015, there was 90% correlation between changes in the URA rental index (central) and employment growth in the financial services sector 20% 10% 0% -10% -20% -30% Employment - Financial & Insurance Services (RHS) URA rental index - central (LHS) 5% 0% -5% 2 Lower correlation in rents and financial services employment from 2012 onwards (73%) reflects a diversification in demand for CBD office space from other sectors such as technology, media and telecommunications, commodities/resources and professional services 3 Employment in the financial institution sector will still have a large influence on the direction of rents in the CBD Source: URA, Singstat, CEIC, DBS Bank Page 4
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Industry Outlook Chart 3: Business Park rents still cheaper than Grade A but pricing advantage has narrowed 20 18 16 14 12 10 8 6 4 2 0 S$ psf/mth Grade A and BP rent spread (RHS) Business Park rent (LHS) Grade A office rent (LHS) 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% 1 Business Park rents have stayed fairly flattish over the past five years, and the pricing advantage expanded when Grade A rents increased by around 20% from 3Q13 to their peak in 1Q15-2Q15 2 Firms which wanted to achieve significant cost savings and were eligible to be located in business parks, had thus relocated from the CBD while maintaining a leaner presence in the CBD 3 However, with the recent fall in Grade A office rents, the business parks' pricing advantage has narrowed Business park rents are now at c47% of Grade A office rents, up from c35% in 1Q15 This may stem the flow of relocations to business parks, especially with limited new business park space coming on-stream over the next few years Source: CBRE, DBS Bank Page 5
Chart 4: Uncertain demand outlook for key sectors that drive CBD office demand Key sectors for CBD office demand Legal, Accounting and Management Services, 30% Insurance Serivces, 8% IT and Other information Services, 21% Financial Services, 41% 1 Key drivers of CBD office demand include financial services, legal and accounting sectors as well as IT and other information services 2 Between 2013 and 2016, these key sectors led CBD office demand, and reported headcount increases of 2-7% pa IT and Other information Services Source: Singstat, CEIC, DBS Bank 3-year headcount CAGR (2013-2016) Total Legal, Accounting and Management Services Insurance Serivces Financial Services 2% 5% 5% 6% 7% 00% 50% 100% Outlook 3 With an uncertain economic environment ahead, the outlook across these sectors has turned more cautious Nevertheless, given still positive GDP growth ahead as projected by our DBS economists, we expect net positive demand for space, though at a slower pace than the more buoyant times from 2012-2013 For 2016, the amount of occupied space in the Downtown Core area rose by 527k sqft, according to the latest URA statistics Page 6
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Industry Outlook Chart 5: Office vacancies to spike on sluggish demand and increase in supply 3,000 2,500 2,000 '000 sqft S$ psf pm 25% 20% 1 We expect the soft demand outlook to result in c40k sqft of net demand for space in the Downtown core region for the next three years 1,500 1,000 500 0 15% 10% 2 Given the large increase in supply, this will result in Downtown Core vacancy rates spiking to 17% and 18% in 2017 and 2018, respectively, from 13% as at the end of December 2016-500 -1,000-1,500 Net Supply: Downtown Core (LHS) Net demand: Downtown Core (LHS) Private Sector Downtown Core vacancy (RHS) 5% 0% 3 Vacancy rates should start trending down from onwards as demand normalises back to the historical average, and supply eases Source: URA, CBRE, DBS Bank Chart 6: DBS Grade A office rental forecast (2016-2017) 3,000 2,500 2,000 1,500 1,000 500 0-500 -1,000-1,500 '000 sqft Net Supply: Downtown Core (LHS) CBRE Grade A office rents (RHS) DBS Bear Case (RHS) S$ psf pm Net demand: Downtown Core (LHS) DBS Base case (RHS) 200 180 160 140 120 100 80 60 40 20-1 Based on the projected increase in vacancies, we expect Grade A rents to bottom out at around S$850 in 2017 before recovering to cs$10 by end-2018 as tenants and landlords position themselves for reduced supply of office space from 2018-2 Our assumption of rents bottoming out at S$850 is also premised on the discount required to entice a tenant to relocate given fit-out costs of S$200-250 psf/mth and office rents of S$1040-1140 psf/mth over the past year 3 While overall vacancy rates are likely to remain elevated in 2018, we believe Grade A rents will recover to cs$10 as the proportion of Premium Grade buildings, which typically charge higher rents, increases within the Grade A category 4 In our bear-case scenario, rents could fall to S$750-800, from S$930 currently before recovering to S$900 in Source: URA, CBRE, DBS Bank Page 7
Chart 7: Two-tier Grade A office market to develop S$ psf / mth 1300 1200 1100 1000 900 800 700 Spread between Premium Grade vs Grade A (RHS) Colliers Premium Grade Raffles Place/New Downtown (LHS) CBRE Grade A Core CBD (LHS) 14% 12% 10% 8% 6% 4% 2% 0% -2% -4% 1 While we expect overall Downtown Core vacancy rate to rise to c18% by 2018, we believe a two-tier market will develop 2 The first submarket will be related to the older buildings in Shenton Way and Raffles Place where vacancy levels will be structurally higher given an uncompetitive product (lower efficiency and older specifications), thus resulting in lower rents 3 The other category will be the premium grade buildings, largely consisting of new buildings currently under construction or built over the past 5-6 years These will command higher rents and achieve lower vacancies This can already be evidenced by the increasing spread between Premium Grade rents as reported by Colliers and overall Grade A core CBD rents as estimated by CBRE 4 Going forward, Premium Grade offices will continue to command 11% higher rents relative to overall Grade A offices, and this spread may widen Source: URA, CBRE, DBS Bank Page 8
Appendix Average occupancy across Singapore Private Sector: Central: Downtown Core Private Sector: Central: Fringe Area Prime Grade Raffles Place/ New Downtown Grade A Raffles Place/ New Downton Grade A Shenton Way/ Tanjong Pagar Grade A Marina/ City Hall Grade A Beach Road Grade A Orchard Road Grade A City Fringe Grade A Suburban 1Q14 903% 878% 928% 969% 972% 985% 957% 940% 962% 979% 2Q14 907% 882% 934% 972% 994% 984% 961% 981% 976% 987% 3Q14 919% 908% 941% 972% 994% 983% 943% 972% 978% 988% 4Q14 900% 869% 882% 982% 996% 975% 964% 972% 976% 916% 1Q15 899% 871% 918% 980% 983% 960% 973% 986% 971% 915% 2Q15 906% 867% 921% 970% 985% 957% 969% 969% 971% 964% 3Q15 911% 867% 914% 978% 962% 974% 892% 962% 975% 963% 4Q15 911% 869% 935% 983% 992% 971% 922% 999% 981% 943% 1Q16 911% 878% 932% 958% 987% 855% 941% 981% 943% 950% 2Q16 909% 888% 937% 955% 982% 951% 932% 974% 938% 950% 3Q16 885% 896% 953% 974% 985% 962% 901% 967% 945% 953% 4Q16 871% 885% 939% 969% 935% 944% 574% 962% 950% 948% 1Q17 875% 881% 960% 964% 929% 948% 678% 966% 953% 963% Source: URA, Colliers, DBS Bank Grade A office rents (S$ sqft/mth) Core CBD Prime Grade Raffles Place/ New Downtown Raffles Place/ New Downton Shenton Way/ Tanjong Pagar Marina/ City Hall Beach Road Orchard Road City Fringe Suburban 1Q14 1025 1067 973 853 946 800 891 791 485 2Q14 1060 1100 996 858 962 800 896 794 491 3Q14 1095 1167 1025 883 976 813 900 798 505 4Q14 1120 1193 1025 900 976 813 900 802 518 1Q15 1140 1193 1041 900 997 813 900 804 518 2Q15 1130 1193 1043 900 1004 813 904 805 518 3Q15 1090 1168 1018 885 979 797 889 780 508 4Q15 1040 1127 985 855 956 781 869 760 499 1Q16 990 1059 950 824 925 756 845 732 489 2Q16 950 1048 947 818 923 750 840 721 489 3Q16 930 1030 933 813 907 750 831 715 486 4Q16 910 1004 918 841 892 772 822 706 485 1Q17 1003 910 839 894 768 822 701 485 Source: CBRE, Colliers, DBS Bank Grade B office rents (S$ sqft/mth) Core CBD Raffles Place/ New Downton Shenton Way/ Tanjong Pagar Beach Road Orchard Road City Fringe Suburban 1Q14 760 831 764 689 854 700 399 2Q14 830 833 770 705 854 715 413 3Q14 850 852 786 714 854 723 423 4Q14 855 865 791 72 861 723 438 1Q15 860 874 791 723 861 731 438 2Q15 855 876 798 723 865 731 453 3Q15 835 861 783 707 850 716 442 4Q15 820 837 759 694 829 702 433 1Q16 795 807 743 680 811 685 424 2Q16 765 792 742 666 806 681 424 3Q16 750 788 731 650 802 663 424 4Q16 735 779 717 631 785 654 424 1Q17 772 716 619 778 654 424 Source: CBRE, Colliers, DBS Bank Page 9
We Cover CapitaLand Commercial Trust Frasers Commercial Trust Keppel Real Estate Investment Trust OUE Commercial Trust Suntec Real Estate Investment Trust Our In-House Experts Derek Tan CA derektan@dbscom +65 6682 3716 Mervin Song CFA mervinsong@dbscom +65 6682 3715 Please note that DBS Bank Ltd may have research coverage in the companies mentioned in this industry report, that have been produced prior to or subsequent to its publication Please refer to the links below for the latest specific equity research reports published on below-mentioned companies and the accompanying disclaimer/disclosure of DBS interest in the companies mentioned in the respective reports Page 10
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