KREIT’s 1H09 distributable income of S$33.2mn (+30% y-y) and DPU of S$0.05 (+27% y-y) met 53% and 54% of our full-year forecasts of S$62.1mn and S$0.092, respectively. Core operating performance in 2Q09 was better than we expected, as management continued to roll over leases at higher rents; including rental support at One Raffles Quay (ORQ), the average portfolio gross rental rate rose marginally from S$8.06psfpm as of end-1Q09 to S$8.13psfpm as of end-2Q09. However, with further deterioration in portfolio occupancy in 2Q09 — committed portfolio occupancy declined to 94.9% at end-2Q09, from 95.8% at end- 1Q09 — we believe that management’s strategy in 2H09F will shift towards trading rental growth for occupancy, and we expect fullyear rental income growth to move closer in line with our forecast.

Leases up for renewal in the remainder of 2009 as a percentage of NLA declined from 9.4% as of end-1Q09 to 5.4% as of end-2Q09, versus a 90bp increase in portfolio vacancy. Compared with 1Q09, when 6% of portfolio NLA was negotiated and portfolio vacancy grew by 3.2pp, tenant retention in 2Q09 clearly improved; the poor tenant retention in 1Q09 was largely on account of the relocation of a significant tenant in Bugis Junction Towers (BJT). That said, leases due for renewal in 2010 remain more or less unchanged at 20% of portfolio NLA, suggesting that tenants remain cautious on pre-commitment.

KREIT’s portfolio was not re-valued during the quarter and valuation stood at S$2.1bn as of end-2Q09. Based on our rental and cap rate assumptions, we estimate that KREIT could book a non-cash revaluation deficit of S$701.4mn over the cycle. Still, with the stock trading at an implied EV of S$994psf, we believe the downside risk of its portfolio valuation is more than reflected in the current share price.

We use sum-of-the-parts net asset valuation of the group's property assets, incorporating our core assumptions for the Singapore property market, which is then further diluted by factoring in any potential equity-raising at the current share price to keep leverage below 0.40.