Background
In recent weeks, the botched Initial Public Offering (IPO) of Wework has created heightened fears that local office property managers will be adversely affected. One of the main reasons why investors are concerned is because of the ~US 900 million operating loss that was disclosed in the IPO Prospectus. Despite strong membership growth, the huge losses raised the question of whether Wework will ever become profitable. Such doubts have sparked fears amongst investors, some of whom have also started wondering if Wework will survive without fresh investor capital. This weakening in WeWork’s position provides negative headlines for the local property managers who have working relationships with Wework. Amongst them, Capitaland Commercial Trust is in the spotlight, having just leased the whole of 21 Collyer Quay to Wework earlier this year.
Given the above context, the question we have is whether Capitaland Commercial Trust will be affected by a potential Wework Debacle.
What is co-working
Co-working has been one of the hottest trends in recent times. Companies have been offering premium office facilities to anyone who will like to rent them. Contrary to the traditional model where only large institutions such as Banks or Tech firms will rent prime office spaces, the new business model makes such Grade A Offices accessible to Individuals and Small and Medium Enterprises (SME). Apart from increasing accessibility to prime locations, Co working spaces also offer communal facilities and perks that rivals those of established firms with great employee perks. From a luxurious pantry to other communal fringe benefits like child care, restaurants, sports facilities, the wide selection of co working options will have you covered.
Leasing of 21 Collyer Quay
At the centre of our discussion on the impact of Wework on Capitaland Commercial Trust’s Share Price and Dividend, is the leasing of 21 Collyer Quay, also known has HSBC Tower. As HSBC will be relocating is operations to Marina Bay Financial Centre, it will not be renewing its lease when it expires in April 2020. Hence, CCT will refurbish the 21 storey tower and lease it out to WeWork in the second quarter of 2020.
With the problems faced by WeWork, those who are learning how to invest their money in Singapore as beginners will understandably be worried and upset about the recent adverse development. This is because WeWork or other co working spaces for that matter, has never leased such a huge tower before. In the event that WeWork does not survive, will it affect the Rental Income of CCT and will CCT be able to lease the building out to other tenants. How badly will CCT be hit by the potential debacle?
The answer to the question of whether it will affect Capitaland Commercial Trust’s Share Price and Dividend is: Highly Likely.
The relationship between lower rental income either due to Asset Enhancement Initiatives or Tenant Defaults and lower distributable income is clear. When property managers cannot put the property to work in receiving rentals, distributions suffer and so do valuations. The only problem is one of magnitude and extent. Hence the right question should be: How bad can it get for Capitaland Commercial Trust and are investors overly optimistic or overly cautious about the situation.
The Previous Tenant v.s Wework
It helps to understand the relationship that CCT has with its current tenant, HSBC. CCT bought the building from HSBC in 2005 and have been leasing it back to HSBC in somewhat of a triple net basis. CCT signed two 7 year leases with HSBC from the period of 2005 to 2029. Compared to the property management fee of 3% NPI, HSBC only pays CCT 0.25%.
When we look at Wework’s tenancy, we realise that it has two characteristic that makes it similar to the agreement with the previous tenant. Firstly, the length of the tenancy is longer than what you would generally expect from a commercial office tenant (i.e. 2-3 years). Further, Wework will also be managing the property on its own instead of relying on capitaland commercial trust’s property management expertise.
Asset Enhancement Initiatives on HSBC Tower
The Asset Enhancement on HSBC Tower will amount to north of 40 million and will be generally about the acquisition of general equipment and refurbishment works on general spaces. This is probably an opportune time to enhance the asset, not just because no enhancement has been done since 2005, but also because many properties in the region are undergoing refurbishment. Examples of which includes chevron house and republic plaza. Hence the 40 million AEI, which amounts to about 10% of HSBC Tower’s current market value, will help keep the property attractive and up to date.
What if Wework Withdraws from Singapore
Gone are the days where if a foreign company comes to invest in Singapore, they will have some pioneer grant from EDB and build a factory that will keep them here for 10-15 years. Today’s companies are typically more footloose and it is hard to say how long they will stay in Singapore. Part of it is due in part due the nature of some companies. As we start to see more start ups, there is a chance that they may exit the market when investor capital which they require in the initial stage of growth dries up. Other reasons can include merger and acquisition where a company gets bought over by another. A good case in point is Uber, which was acquired by Grab and quickly exited the private hire vehicle market.
If Wework withdraws from Singapore, we do not think that it will have a significant impact on CCT. While we know that Wework will represent 5.5% of total gross rental income if it were to completely replace HSBC as one of CCT’s major tenants, the good diversification of tenant mix means that the impact of Wework’s potential withdrawal will not put CCT’s financial viability in jeopardy.
Further, most of these tenants typically pay up some form of deposit. This deposit safeguards CCT in the event of an early termination of the tenancy agreement as it gives CCT the buffer it needs to look for another tenant. While the length of time for CCT to find another tenant can vary, it will be easier in a cyclical upturn which is what we are going through as of this writing, as compared to if office rental rates are at cyclical lows.
Conclusion
We know that many investors fear the potential that Wework will cease to exist and have linked that adverse possibility to the financial prospects of CCT. However, it is important to quantify the degree of exposure and downside that CCT will experience. As we do not believe that a potential WeWork exist will cause Capital Commercial Trust any significant financial duress, we believe there can be opportunities if negative sentiment swings to an extreme.
