Singapore REITs - Tug and tussle between the doves and the hawks
- A dovish Fed outlook and a potential sector re-rating ahead of a broader physical market recovery in 2018 lead us to rotate into this under-owned sector.
- Yellen assured the markets that the Fed has not decided on a faster pace of tightening, and that the Fed can tolerate inflation temporarily overshooting 2%.
- On the flip slide, a growth-led rate increase implies faster/sharper macro recovery.
- We believe REITs could re-rate on a broader physical market recovery in 2018.
- Our sub-sector preference is unchanged. The market has not priced in a recovery for hotels. Fortune favours the brave if our view of a 2018 recovery pans out.
- With S-REITs the best performing REIT market globally, our attention shifts to laggards, CDREIT and MAGIC.
Rotate into this under-owned sector
- Interest in S-REITs has picked up after the FOMC Mar meeting. YTD, the REIT index (+6%) has relatively underperformed the developer index (+19.1%) and the broader market (+9.6%). Post-FOMC Mar meeting, however, the REIT index (+1.5%) has outperformed both the developer index (-0.7%) and the broader market (-0.2%).
- With both S-REITs and Singapore developers trading around mean of a c.20% discount to RNAV and c.1x P/BV, respectively, the valuation gap between these two have arguably dissipated. From our recent marketing with investors in the first two weeks of Mar, we sense that most Singapore-only funds have exposure to developers and are light on S-REITs, while regional property specialist funds are seemingly skewed towards Hong Kong/China.
- Given the fund flows, we expect investors to take some profit from the cyclical sectors, which have done well, and find a temporary hiding in S-REITs. Coupled with a more dovish Fed outlook and potential sector re-rating ahead of a broader physical market recovery in 2018, we shift our sector posture from Underweight to a tactical Overweight. We continue to expect the sector to trade in a tight band. Downside risks are a sharp rise in the 10-year Singapore Government bond yield (led by Fed rate hikes) or a sharp deterioration in the rental markets.
Attention shifts to laggards
- With S-REITs the best performing REIT market globally, our attention shifts to laggards. Among which, we like CDREIT and MAGIC.
- We deem the risk-reward for CDREIT favourable, on the premise of a recovery for the hospitality sector in 2018. As visibility is low, the sub-sector is the only one which has understandably not priced in a recovery. Hence, the stock would generate the most alpha if our view turns out to be correct.
- CDREIT remains the bellwether for Singapore’s hospitality sector. Catalysts are a better-than-expected Singapore performance vs. peers, robust NZ market and improvement in the Maldives.
- MAGIC’s share price performance has taken a dive after the unexpected implementation of VAT and higher property tax at Gateway Plaza. While investors are unnerved by the policy changes, we believe that the stock has been unduly punished, and could re-rate upon a favourable finalisation of the actual VAT. In addition, with Festival Walk making up c.70% of its revenue, we deem MAGIC a unique proxy for both the nascent Hong Kong retail recovery and US$ strength. Catalysts are continued positive rental reversions for Festival Walk and a better-than-expected Beijing office market.
Fed signals a boon for bonds
- At the Mar FOMC meeting, the Fed, as expected, hiked its benchmark rate for the second time in three months by 25bp to the range of 0.75% to 1.00%. Minneapolis Fed President Neel Kashkari was the sole "no" vote.
- Buoyed by continued momentum in the labour market, Janet Yellen said the hike signaled her view that “the economy is doing well”. Yellen noted that core inflation – excluding volatile food and energy prices – is at 1.7%, just below the Fed's 2% target, while job creation is growing ahead of the pace needed to sustain the 4.8% unemployment rate. Meanwhile, the Fed’s dot-plot diagram points to two more rate hikes this year.
- More importantly, Yellen sought to ensure markets that the Fed has not decided on a faster pace of tightening, and signaled that the Fed can tolerate inflation temporarily overshooting the 2% target as it balances growth and monetary policy.
- Interestingly, Yellen also noted that Fed’s latest decision has not factored in any expectation of growth stemming from President Trump’s policy promises on taxes, deregulation and trade, suggesting that the rate outlook is Fed-driven, rather than “Trump reflation”. Precisely how Trump’s policies will play out remains a major uncertainty for the Fed. To illustrate, US Treasuries slipped on Trump’s failure to repeal the existing healthcare act, which dented tax savings and deficit reduction that would be significant for Trump’s more permanent fiscal proposals. Balanced against the outcomes of the multiple elections in Europe and a hard/soft landing from Brexit, we also cannot rule out the likelihood that US Treasuries could peak in 2017.
Buy ahead of physical market recovery in 2018
- On the flip side, a growth-led rate increase implies faster/sharper macro recovery. While earnings could lag, we believe that REITs could re-rate on improved sentiment due to a broader physical market recovery in 2018. The momentum of rental reversion turning positive could also result in sector yield compression.
- To illustrate, the last interest rate up-cycle (May 04 to Jun 06) coincided with a period of high growth for S-REITs. Consequently, the sector yield spread compressed to an average of 220bp vs. long-term average of 380bp.
- During the period of the taper tantrum (mid-2013 to 2014), yield spread averaged 390bp, despite bouts of volatility, as “lower-for-longer” rate environment materialised. Yield spread expanded to an average of 400bp for 2015 and 460bp for 2016 as the operating environment deteriorated; while Fed tightened the monetary policy towards end-16 with US growth stabilising.
- As we head towards a broader physical market recovery in 2018, we believe that sector yield spread could tighten once again.
Sub-sector preference: hotels could deliver the most alpha
- We reiterate that the physical market is moving towards the tail-end of the supply cycle, even though there is still the 2017 tower of supply to contend with.
- Among the sub-assets, we believe business parks would be the first to recover, given negligible supply post-16 and Singapore’s focus on higher-value activities. Next, healthy take-up at the new developments, tapering supply post-17 and a more upbeat GDP growth points towards Grade A CBD bottoming out towards year-end.
- Faced with structural challenges, retail remains in a gridlock, though we highlight that retail REITs’ malls are well-positioned and enjoy niche positions.
- Given the strong completions for warehouses and hotels in 2017 – while some delivery slippage is to be expected – we believe that we would only see green shoots of recovery next year.
- Balanced against market expectations, however, we found that the market has priced in the recovery of office, retail and industrial to some degree, though we think that there could be further yield compression at the cusp of a recovery cycle. Office, retail and industrials are trading around mean.
- On the other hand, hotel is trading at 580bp spread vs. mean of 450bp. This is understandable, given a number of false dawns that investors have experienced. However, with minimal supply expected from 2018 onwards, no new supply of hotel land, and with a more stable macro by then, we believe RevPAR could recover from 2H18.
- Looking ahead of the curve – albeit amidst mixed data points – we recommend that investors start positioning in the hospitality sub-segment. Fortune favours the brave if our argument for a 2018 recovery pans out.
CDL Hospitality Trust
- HOLD, TP S$1.42, S$1.43 close
- We deem the risk-reward for CDREIT favourable, on the premise of a recovery in the hospitality sector in 2018. The sub-sector is the only one which has not priced in a recovery.
- CDREIT remains the bellwether for Singapore’s hospitality market.
Mapletree Greater China Commercial Trust
- ADD, TP S$1.13, S$1.02 close
- We deem that MAGIC is a unique proxy for both the nascent Hong Kong retail recovery and US$ strength.
- Catalysts are continued positive rental reversions for Festival Walk and a better-than-expected Beijing market.