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The Good and Bad From Keppel REIT’s 2018 Second-Quarter Report Card

Keppel REIT (SGX:K71U) announced its financial results for the first half of 2018 on Monday, 16 July. The REIT owns a portfolio of office buildings in Singapore and Australia. Prominent buildings in its portfolio include Ocean Financial Centre and a one-third stake in Marina Bay Financial Towers 1,2 and 3 and Marina Bay Link Mall.

Here are some of the positives and negatives from its most recent earnings updates.

The bright side

During the second quarter of the year, which ended on 30 June, Keppel REIT collected gross rent of S$37.9 million, 0.4% more than the previous year. Distributable income likewise inched up 1.9% to S$48.3 million from S$47.4 million previously.

The group also has a relatively high retention rate for its portfolio at 77%. The weighted average lease expiry stands at 5.2 years, which is long by a commercial REIT’s standard and provides it with visible rental income for the foreseeable future.

In addition, the average signing rent for Singapore office leases during the first half of the year was S$10.74 per square foot, which is higher than the average rental rates of Grade A office of S$10.10. With a tapering supply and recovering market fundamentals, the outlook for office rental rates in Singapore over the medium term remains positive. Below is a chart showing the rental rates over the past three years:

Source: Keppel REIT 2018 Q2 Earnings Presentation

Keppel REIT is also in the midst of developing a Grade A office tower at Spencer Street in Australia, which it has a 50% interest. The building is expected to be completed in the fourth quarter of 2019, and a 30-year lease with Victoria Police has already been signed. The lease will provide steady income stream over a 30-year period and give a 6.4% property yield with fixed annual rental escalations.

The not-so-bright side

Perhaps the main downer for unitholders is the fact that despite the higher property income, distribution per unit (DPU) remained unchanged from a year ago at 1.42 cents. This is because of an enlarged unit base as units are paid out as management fees each quarter.

On top of that, the REIT currently has aggregate leverage of 38.6%, which looks to be on the high side. In addition, it has around S$149 million worth of perpetuities, which it has to pay interest on regularly. This has resulted in an interest cover that stands at 4.3 times, which is lower than many of the other REITs. The low interest cover and high gearing may limit the REIT’s ability to take on more debt in the future to fund additional acquisitions.

Moreover, around 23% of Keppel REIT’s debt is on a floating rate. Management estimates that a 0.5 percentage point change in interest rate will have a 0.1 cent change in DPU. With interest rates expected to rise two more times this year and at least three times in 2019, there could be some changes to DPU in the future.

The Foolish bottom line

The second quarter of 2018 has been a mixed one for Keppel REIT. Despite higher rental rates, a higher number of outstanding units have diluted DPU. Higher interest rates, coupled with lower interest cover may affect Keppel REIT’s distributions in the future.

On the flip side, there are some positives too. Office rents in Singapore seem to be improving, and this development will provide a welcome boost to rental income.

At the time of writing, units of Keppel REIT exchanged hands at S$1.18 per unit. That translates to a price-to-book of 0.84 and an annualised distribution yield of 4.8%.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia own units of Keppel REIT.