Singapore REITs - UOB Kay Hian 2016-07-18: Yield Compression Picking Up Pace

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Singapore REIT ASCENDAS REAL ESTATE INV TRUST A17U.SI  KEPPEL REIT K71U.SI  CDL HOSPITALITY TRUSTS J85.SI  MAPLETREE INDUSTRIAL TRUST ME8U.SI  SUNTEC REAL ESTATE INV TRUST T82U.SI 

REITs – Singapore: Yield Compression Picking Up Pace

• We have raised our Singapore REIT target prices by 7% on average as we cut our risk-free rate assumptions by 50bp on the back of rising expectations of a prolonged low interest rate environment amid increased uncertainties as Brexit negotiations unfold. 
• Maintain OVERWEIGHT with AREIT, CDREIT and KREIT as our top picks. 
• We downgrade MapleTree Industrial Trust to a SELL (from BUY) and Suntec REIT to a HOLD (from BUY), as we see limited upside post the recent strong share price performance.

WHAT’S NEW

Prolonged period of low interest rates, as the UK grapples to revoke EU membership. 

• Post the Brexit referendum on 23 June, 10-year SGS shed 31bp, to reach 1.73% on 15 July). 
• Newly-appointed Prime Minister Theresa May has indicated a further delay in formal negotiations towards an EU exit, in hopes to get Scotland on board.

ACTION

• Raise target prices on reduced risk-free rate; maintain OVERWEIGHT with AREIT, CDREIT and KREIT as our top picks. We lower our risk-free assumptions by 50bp from 3% to 2.5%, on expectations of a prolonged low interest rate environment amid increased uncertainties as Brexit unfolds. We raise our target prices for REITs by 2.2- 11.2%, on our lower risk-free rate assumptions.
• Downgrade MapleTree Industrial Trust to a SELL (from HOLD) and Suntec REIT to a HOLD (from BUY), as we see limited upside post the strong share price performance.

ESSENTIALS

Protracted low interest rate environment likely until late-18, as Brexit negotiations play out. 

• Newly-appointed Prime Minister Theresa May had earlier indicated that Article 50, the formal mechanism to revoke EU membership, will not be triggered before Scotland’s support. Recall that 62% of Scotland voted to remain in the EU. The uncertain outlook on protracted exit negotiations during the formal exit process suggests that interest rates could stay depressed until late-18. Recall that the 10-year SGS was at 2.6% at the start of 2016.

Lowering risk-free assumption; ample room for yield compression. 

• Post the Brexit referendum on 23 June, 10-year SGS shed 31bp, to reach 1.73% on 15 Jul, 127bp higher than our risk free assumption of 3%. We lower our risk-free assumptions by 50bp to 2.5%, on expectations of a prolonged low interest rate environment amid increased uncertainties as Brexit unfolds. Yield compression to the long-term mean levels of 3.9% implies another 12% upside, despite a 9.2% ytd run up in the S-REIT index, contrasting favourably against a 1.5% ytd increase in the STI index. With Singapore REITs yielding 6.3% and the 10-year Singapore government bonds yieiding 1.73%, the REIT yield spread of 4.54% remains most compelling in the region. Yield compression to the upcycle spread level of 2.8% implies over 30% upside potential.

Hospitality: The comeback kid? 

• In 5M16, overall visitors were up 13.3% yoy to reach 6.9m visitors, driven by resurgent Chinese tourists. China is currently Singapore’s largest tourist market after overtaking Indonesia last month, and the exuberant growth in Chinese visitors has been heartening, especially against the backdrop of a higher visitor base from Apr-Dec in 2015.
• In an earlier note, we pointed out that sustained Chinese arrival growth from April-May onwards would point to a material coup for Singapore’s hospitality scene, as phenomenal growth in the months before April this year stemmed from a lower base effect after languishing Chinese arrivals from Oct 13 onwards. Nonetheless, we are cognisant of the sizeable supply of about 3,930 rooms (6.4% yoy expansion) set to hit the market in 2016. This may partially explain the slight dip in industry RevPar (-0.8% yoy) for 5M16, as the sector grapples with supply digestion.

Industrial: Business park segment standing out on supply front. 

• CBRE estimates 2016 business park pre-committed supply at 44% (no known notable supply thereafter). While the newly-completed Ascent and MBC II have added pressure to the market, forward supply consists of built-to-suit projects which are largely pre-committed. We note that media reports in Feb 16 identified Johnson and Johnson possibly taking up 170,000sf of space at business/science park Ascent as its first anchor tenant. CBRE also purports signs of leasing interest from IT and pharmaceutical firms at the 1.1m sf (NLA) Mapletree Business City (MBC) Phase II (expected completion 2Q16). Accounting for about 49% of its portfolio value, we reckon AREIT could be a good play on the relatively more resilient business/science parks and hi-spec segments within the industrial sector.

Office: Continued easing. 

• According to CBRE, Grade-A office rentals declined a further 4% qoq in 2Q16 to hit S$9.50 psf pm (1Q16: S$9.90 psf). This represents a 17% decline in rentals from 1Q15’s peak of S$11.40 psf pm. 
• With 2Q16 seeing the fourth consecutive quarter of negative office space absorption islandwide, landlords likely had to compromise on rentals to retain new tenants or attract new ones with even the Grade-A market registering negative net take-ups in the quarter. 
• However, we opine that this steep correction is not the beginning of an office downcycle as limited supply of office space from next year onwards will help to improve the office segment’s fundamentals. 
• We expect office rents to recover next year post the 10-15% correction this year.

Retail: Challenging environment. 

• 2Q16 saw retail rentals in Orchard Road decline 1.1% qoq, an acceleration compared with the previous quarterly rentals. Marking the sixth quarter of decline, this also implies the prevalence of a tenant's market in the Orchard retail scene. 
• Island wide, the retail environment is expected to remain challenging due to the increased supply, rising costs and threat from alternative retail channels. CBRE expects this to persist in the medium term, with landlords increasingly taking defensive steps like forward renewals to sustain occupancy levels. 
• Retail landlords CapitaLand Mall Trust (CMT) and Frasers Centrepoint Trust (FCT) have guided for more moderate rental reversions and we expect retail rental growth to trend in line with inflation. 
• Acquisitions and asset enhancement initiatives (AEI) are expected to continue catalysing growth, ie CMT’s Funan DigitaLife Mall (slated for 3Q16 commencement), FCT’s Northpoint Shopping Centre (commenced Mar 16) and Suntec’s Park Mall.

RECOMMENDATION, TARGET PRICE AND ASSUMPTION CHANGES

Vikrant Pandey UOB Kay Hian | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2016-07-18

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.70 Up 1.55

BUY Maintain BUY 2.84 Same 2.64

BUY Maintain BUY 1.31 Up 1.22

SELL Downgrade HOLD 1.70 Up 1.61

HOLD Downgrade BUY 1.94 Up 1.81