Singapore Office Yields Should Rise Amidst Higher Interest Rates

SINGAPORE – While the local office rental market performed strongly last year, with office rents in the city-state’s central region climbing 11.7 percent year-on-year in 2022, the current yields of office properties here don’t make sense in the high interest rate environment, according to a commentary published on The Business Times on Monday afternoon (27 February, SGT).

At present, the net yield of a prime office property in Singapore is slightly above 3 percent compared to a borrowing cost of more than 4.5 percent per year. This is after the three-month compounded Singapore Overnight Rate Average (SORA) inched up to about 3.2 percent as of 24 February 2023.

But the news outlet’s Senior Correspondent Leslie Yee pointed out that capitalisation rates (cap rates) utilised to value prime office assets here have remained fairly constant. However, applying higher cap rates would result in lower property valuations.

“Typically, the income capitalisation approach used to value investment properties involves dividing the estimated net property income (NPI) by the cap rate. The capitalisation rate adopted reflects an appropriate investment yield for the said property,” he explained.

For the end of 2022, the cap rates for Singapore office portfolios were 3.3 to 3.6 percent for Keppel REIT’s office holdings, 3.4 to 3.5 percent for Suntec REIT, and 3.4 to 3.8 percent for CapitaLand Integrated Commercial Trust, which owns S$8.37 billion worth of office assets in Singapore’s central business district (CBD) as at the end of last year.

For example, an office tower with an NPI of about S$35 million per year is valued at around S$1 billion if the cap rate used is 3.5 percent. But if the capitalisation rate rises to 4.5 percent to reflect the higher prevailing borrowing costs, the office property’s value would drop by 22 percent to S$778 million if the NPI remains the same.

For the valuation to remain at S$1 billion at a cap rate of 4.5 percent, the NPI needs to increase by almost 29 percent to S$45 million, Yee calculated.

He thinks that yields of Singapore office assets may need to increase in order for more transactions to happen, even though there is robust rental and investment demand for top-notch office space here.

“After all, one gets a yield of close to 4 percent from buying Singapore’s latest six-month Treasury bill.”

“But the days of investors bingeing on cheap debt to fund property buys may not return for a long time. This can help Singapore-listed REITs, which are constrained by gearing limits, in competing for acquisitions with other purchasers who can gear up more,” added Yee.