Suntec REIT reported distributable income of S$47.7m (+13.5% yoy) and DPU of 2.98 cents (+6.6% yoy) for 2Q09. The results were in line with our forecast DPU of 3.03 cents.

A challenging office market. Occupancy for Suntec Office Towers deteriorated from 96.3% at Mar 09 to 92.5% at Jun 09. Although UBS and Infocomm Development Authority (IDA) have renewed their leases, both tenants have returned surplus space to Suntec REIT as they consolidate and streamline their activities. New leases at Suntec Office Towers were signed at average rent of S$8.24psf, a 17.3% decline qoq. Suntec REIT has renewed a total of 375,000sf of office space in 1H09.

Retail portfolio stays resilient. Occupancy for Suntec City Mall remains high at 98.6% while average passing rent grew 1.2% yoy to S$11.05psf per month. Gross retail revenue increased marginally by 0.5% yoy to S$34.2m. Suntec REIT did not revalue its portfolio of investment properties for 2Q09 results. Thus, NAV/share is maintained at S$1.96.

Lumpy lease expiry for retail portfolio. Leases for 272,068sf or 26.1% of Suntec REIT’s retail space will expire in 2H09. They include 140,000sf of retail space taken up by anchor tenant Carrefour at Suntec City Mall. The large amount of retail space up for renewal is a concern. This is made more challenging by the contraction in visitor arrivals and retailers’ reluctance for expansion.

Embarking on AEIs. Suntec REIT is currently upgrading the office lobbies for all five towers at Suntec Office Towers. It also plans to construct a covered walkway linking Suntec City to the new Promenade MRT station, to be completed in mid-2010. Total capex for both asset enhancement initiatives (AEIs) is expected at less than S$5m.

Office market not out of the woods. According to CB Richard Ellis, average prime and Grade A monthly rents declined 18.2% and 17.5% qoq to S$8.60psf and S$10.15psf respectively in 2Q09. Take-up rate is likely to remain in negative territory in 2H09 as there is usually a time lag between retrenchment exercises and the release of excess office space. However, the pace of decline slowed with improved sentiment and stabilisation in the economy.

We expect rents for Grade A office space to correct two-thirds from the peak to S$6psf due to supply coming on-stream, especially in 2010. We have assumed average occupancy rate tapering to 86% for the office portfolio and 92% for the retail portfolio by 2Q11. We trim our 2009 and 2010 DPU forecasts marginally by 1.8% and 2.5% respectively to 11.2 cents and 7.7 cents.

Our fair price of S$0.82 is based on a two-stage Dividend Discount Model (required rate of return: 7.7%; terminal growth: 2.5%). Maintain SELL.