Why CapitaLand Commercial Trust (CCT) is deeply undervalued

Info 0009_Stock Initiation - CCTDear readers, over the past 2 months, the REIT market has taken a beating with concerns over rising interest rates and ongoing trade wars. Capitaland Commercial Trust (CCT) has not been spared from this price correction, declining from a 52-week high of S$2.03 to a trough of S$1.63 per share.

In contrast, the office transaction market continue to be robust with recent transactions consistently closing at sub-3% NPI yield. Valuation of office assets in the private market remain firmly on the uptrend while prices of office S-REIT like CCT is on a continuous decline. In view of this disconnect between the valuation of physical commercial real estate (CRE) and public REITs, REIT-it firmly believes that value has emerged from the price correction in the office REITs space.

REIT-it believes that CCT, being the largest office S-REIT and having the largest exposure to the Singapore office space, is the most prime to benefit from this valuation disconnect. Detailed explanation below:

Unlocking value amidst high valuations

Despite rising interest rates, capitalization rates in the commercial office market have not gone up in tandem to reflect the appropriate risk premium. Instead, investment interests continue to drive down the transaction capitalization rates, allowing for property valuation to continue its uptrend.

The Singapore office market has seen transactions closing at record high in recent days with 55 Market Street catching the eyes of office investors. The 16-storey 999-year leasehold commercial asset was sold for a consideration of S$3,020 psf, representing 44.5% premium above its valuation as at July 2018. The implied transaction net property income (NPI) yield stands at a record 1.7% based on end March NPI.

55 Market Street is not the only office building that has transacted at sub-3% NPI yield in recent months. Manulife Centre on Bras Basah Road is reported to be nearing a transaction with an implied NPI yield of mid-2%.

On the backdrop of capitalization rate compression, CCT has been able to unlock value for its shareholders underpinned by the most recent divestment of Twenty Anson to AEW on a 2.7% NPI yield in June 2018. This transaction is on top of the disposal of One George Street and Wilkie Edge at an exit yield of 3.4% and 3.2% respectively in 2017.

Should CCT be able to dispose more Singapore-based assets in this climate at a premium, shareholders will be the direct beneficiary of such disposal gains.

Recovery in office demand expected

“Based on the CBRE data, Grade A CBD office rents had risen 3.2% q-o-q and 8.4% y-o-y to S$9.70 psf/mth by end 1Q18, having bottomed in 1Q17-2Q17 at S$8.95 psf/mth.” (Source: DBS Research) It is to note that the current rent rate is still a distance off S$11.40 psf per month achieved in 2015.

Improvement in Grade A CBD office rents is expected to continue on the backdrop of strong net absorption in Singapore office space coupled with a lack of new supply over the next 3 years. Occupancy for Grade A CBD office has improved to 94.2% from 93.8% in 4Q17.

Office Supply

Source: CCT

The recovery in office demand has already prompted prospective and existing tenants to enter into forward leasing agreements at higher rents as most fear that rents would rise further over the next few years given limited new supply. This further proves the high demand in the Singapore office market.

Leasing Update

Source: Business Times

With c.36% of leases up for renewal over the next 2 years, REIT-it believes that upside remains for CCT which is poised to ride this upturn in Singapore office market.

Lease Expiry Profile

Source: CCT

Capitaland Commercial Trust continues to trade near/below NAV

As of 17 July 2018, at the price of S$1.75 per share, the implied P/NAV of CCT stands at 0.99x. Having a P/NAV of near 1.0x may imply that CCT is fully valued at current price. However, we should note that independent valuation of portfolio asset is done once a year, which in this case for CCT, is as of December 2017. As such, the NAV that we are using to calculate the P/NAV may be outdated considering that valuation of office assets has gone up significantly over the last 6 months.

Portfolio Valuation

Source: CCT

A quick look at the valuation done in December 2017 revealed that CCT’s office assets were valued using a capitalization rate of 3.6% to 4.1%. This range, as compared to the sub-3% NPI yield seen on recent transactions, would imply that CCT’s portfolio is at least 20-25% undervalued.

The undervaluation can be confirmed in the transaction of Twenty Anson when the sales price was reported as a 19% premium over valuation as of 31 December 2017.

Sales of Twenty Anson.png

Source: CCT

Considering the above, REIT-it believes that Capitaland Commercial Trust has deep underlying value and would propose a target price of S$2.10 for CCT based on implied 20% undervaluation.

The writer is vested in Capitaland Commercial Trust. 

Concept Sharing:

REIT-it has seen many REIT analysis using P/NAV or more commonly known as P/B as a primary indicator of whether a subject REIT is over- or under-valued (i.e. P/NAV > 1 = overvalued; P/NAV < 1 = undervalued).

When using such ratios, readers should note the nature of the figures involved before basing any decisions off them. For the case of P/NAV, the net asset value (NAV) for a REIT consists mainly of asset valuation done once a year (usually December 31). This necessarily means that the NAV figure would require adjustments throughout the year as valuation of the REIT’s properties may have experienced significant changes along with the private real estate market.

As such, it would be hasty for one to dismiss a REIT as overvalued when one sees a P/NAV of 1.4x or claim that a REIT is undervalued just because the P/NAV is 0.7x.

Hope you learnt something from this analysis on CCT. Should you have any queries or would like to learn more about evaluating REITs, please email Caleb at reitit.sg@gmail.com.

 

All rights reserved to reitit.org. Any form of duplication, distribution and re-posting of this material is strictly prohibited and is an infringement of the copyright law in Singapore.

Disclaimer: This report reflects only the sincere opinion of the writer. Reader should exercise personal discretion when deciding on any investment.

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