UOL bulk leases: a good or bad strategy?

A RECENT long-lease agreement between UOL Group and the Central Provident Fund (CPF) Board has raised an interesting question: Is it better, from a shareholder point of view, for an office landlord to lease out a large chunk of office space on a long lease to one single tenant or to have the space divided and leased to a number of smaller tenants on shorter leases and thus achieving higher per-square-foot (psf) rents?

The lease agreement between UOL Group and the CPF Board involves the renting of nearly 210,000 sq ft that will be vacated at Novena Square’s two office towers by Procter & Gamble (P&G) when its leases expire in two tranches: in mid-2015 and 2016.

At first glance, having smaller tenants is the better option, as it appears to maximise revenues. But on closer examination, this is not necessarily the case.

The CPF Board will start renting the space at Novena Square from the fourth quarter of next year. The initial lease term is understood to be 10 years with options for renewal. Talk in the market is that rental rates are likely to be staggered, but the average monthly rent over the duration of the lease term is believed to be in the low $7 psf range.

This is the second major bulk office leasing deal UOL has announced in the past three years. In October 2011, its hotel arm Pan Pacific Hotels Group revealed it had inked a 30-year-lease agreement with the Attorney General’s Chambers (AGC) for the whole of One Upper Pickering, a 15-storey office block with 87,067 sq ft net lettable area (NLA). That building was completed in late 2012 and the AGC began operating from the new premises in March 2013.

Lump-sum payment

Instead of paying a monthly rental, the AGC paid an upfront lease premium of $127.2 million in one lump sum. Based on a straight-line calculation, that sum translates to a monthly rent of just over $4 psf. When service charge is included, net present value calculations reflect an average gross effective monthly rental of about $7 psf – below the $9-$10 psf that comparable buildings in the vicinity are said to be commanding. Likewise at Novena Square, rents are said to be around $8-$8.50 psf a month. Both figures apply to smaller areas of under 5,000 sq ft.

So it is that UOL’s bulk leasing deals at One Upper Pickering and Novena Square Towers beg the question whether the property group could have fetched higher rental income by sourcing for a string of smaller tenants – instead of jumping into a deal with a large tenant, and that too ahead of the space being available. Moreover, the timing of the deal with the CPF Board is interesting given that UOL, in its recent first-quarter results statement, said: “Rentals of office space are expected to move upwards amidst rising market confidence.” So why the rush if the Singapore office market has seen improved conditions since the second half of last year?

Confidence in the sector is being boosted by reports of improved demand from occupiers in sectors such as oil and gas, pharmaceutical, social media, information technology and insurance. Moreover, CBD (central business district) office supply is expected to be tight in the short term, with no major completions expected next year. Given this positive short-term outlook for the Singapore office market, landlords are able to push for higher rents. However, supply is expected to pick up again starting from 2016 – with major completions such as Guoco Tower in Tanjong Pagar, 5 Shenton Way, Marina One, Duo in Ophir Road and Frasers Centrepoint’s project in Telok Ayer Street. While there are new office demand drivers, there hasn’t been much visibility on new demand from banks, the major occupiers of CBD offices.

UOL may have had this in mind in deciding to lock in the CPF Board as an anchor tenant at Novena Square for the space to be vacated by P&G. Clinching the CPF Board at Novena Square is no small feat either. While Novena Square is a good class development, it is 14 years old and in recent times, large occupiers typically have preferred to move into new developments.

Strong plus point

Moreover, the strong tenant covenant that comes from blue-chip government occupiers such as the CPF Board and AGC is a strong plus point as far as security and stability of leases go. There are other plus points in UOL’s strategy. In the case of Novena Square, the near dovetailing of the expiry of the first tranche of P&G’s lease with the start of the CPF Board’s lease allows UOL to minimise vacancy. And by leasing a chunk of space to a single tenant, it extracts higher NLA – compared with carving out smaller rental units, which entails setting aside more corridor space and other common areas. In other words, while UOL may have been able to achieve higher $ psf rents from renting the space to many small occupiers, the overall rental collection may not be higher.

Moreover, having a large number of small tenants on short leases typically of three years means that there’re likely to be more changes of tenants, implying higher incidence of void space and vacancies. And commissions/marketing costs will likewise go up for a landlord that has to find replacement tenants more frequently – compared with taking a blue-chip tenant on a longer lease.

In the case of a deal like One Upper Pickering, the substantial sum of $127.2 million from the upfront 30-year-lease sale would come in handy to a landlord: to repay borrowings or even fund the development itself, for instance.

Some industry watchers expect more government agencies to seek long-term leases for large office space as they decentralise. They can negotiate for lower rents, and by locking in a lease for a longer period, are assured of continuity of operating from the same location.

Given the plus points for landlords, such leases may not be a bad idea.



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