Singapore Industrial Real Estate - DBS Research 2016-08-22: En Route To Change

Singapore Industrial Real Estate - DBS Research 2016-08-22: En Route To Change SREIT Industrial REIT ASCENDAS REAL ESTATE INV TRUST A17U.SI MAPLETREE INDUSTRIAL TRUST ME8U.SI

Singapore Industrial Real Estate - En route to change

  • Demand for industrial properties to change alongside the restructuring of manufacturing sector. 
  • Business parks and hi-tech space to do well among industrial types. 
  • Industrial REITs to undertake more developments and diversify overseas. Our picks are A-REIT and MINT. 

Manufacturing in the new Singapore economy

Singapore to chart the way for Manufacturing 2.0, industries driving the new innovation economy will be different from the past. 

  • Singapore’s manufacturers are struggling to maintain their market share as competition continues to heat up, while domestic cost pressure from ongoing restructuring efforts erodes their profit margins and pricing ability.
  • Beyond external headwinds and global uncertainties, we believe that industrial landlords can continue to play a part, as Singapore needs to chart a new roadmap for the manufacturing sector in the long term. The manufacturing sector, as with most other sectors of the economy, will continue to undergo transformation with the ongoing domestic restructuring efforts. Through this period, higher operating costs and regional competition will continue to weigh on growth.
  • Looking ahead, the industries expected to drive Singapore’s new innovation economy will be different from that of the old. The Singapore government has placed a focus on growing the info-communication, chemicals, biomedical and precision engineering sectors. In addition, we see new businesses in digital technologies, such as automation, additive technologies, and artificial intelligence, as new opportunities for Singapore to capture. The push toward “factory-less” goods production, which involves moving upstream in the manufacturing process, e.g. venturing into product design and research and development (R&D), will also represent a new growth opportunity for Singapore.

Changing needs in industrial space

Varying demand for real estate space; business parks, hi-specs industrial and data centres are the way to go. 

  • In our view, we see varying demand drivers for the various types of industrial space in Singapore. We believe that this will result in more demand for specialised facilities, which will be mainly build-to- suit (BTS) in nature; while we remain positive on the growth in demand for business parks and hi-tech industrial space, as specifications will remain attractive for users in the future. Data centres could also be a new area of growth given Singapore’s smart nation initiative, which will drive up demand for data.
  • The multi-user and single-user factory space will face the brunt of the ongoing restructuring efforts and landlords should consider upgrading their properties to higher specifications in order to remain competitive and stand out among the competition.
  • In the warehouse space, landlords can consider attracting demand by upgrading their warehouses in order to meet the changing demands of end-users. 
  • Apart from typical end-users in the third-party logistics (3PLs) space, we believe that new and emerging demand drivers will come from the food & beverage industry (F&B), fast-moving consumer goods and e- commerce players.

Negative net absorption in the near term; rentals remain under pressure. 

  • We project that demand for industrial space will remain weak as businesses close or consolidate, amid a surge in new supply completions. As such, net absorption is expected to remain negative at 395,000 square metres (sqm) to 776,000 sqm, resulting in vacancies spiking to in excess of 10% in 2016 to 2019. 
  • Industrial landlords are likely to turn on the defensive as they face the twin headwinds of both increased competition from new industrial space and business consolidations.

Industrial landlords should undertake developments; acquire overseas to diversify for growth and sustain NAVs

Industrial REITs to turn defensive; organic earnings outlook flattish at best. 

  • While the impact of higher supply and weak demand will likely weigh down on market rents and earnings in the immediate term, we expect industrial landlords to turn defensive and maximise tenant retention rates at the expense of higher rates. 
  • Given expected structural changes in real estate needs and requirements from manufacturers, inevitably, we project higher portfolio vacancies going forward. We project that distributable income trends are likely to be flattish over FY16-18F. 
  • We expect the highest pressure in FY16F, distributions are projected to range between +1% to a fall in 7% in FY16.

Industrial REITs should look to more developments to future proof their portfolios. 

  • An alternative strategy which we believe can drive longer-term sustainability is to undertake more developments, enabling industrial REITs to future proof their portfolios given the changing needs. These developments could entail either a total change in use and positioning or an intensification of plot ratios to maximise value. 
  • While the industrial REITs have periodically undertaken such work, we see an intensification of such development activities going forward. The recent increase in development limits from 10% to 25% supports such development activities.

Geographic diversification remains a key strategy. 

  • In the meantime, we expect industrial REITs to continue to look for acquisition opportunities and we see venturing overseas as a strategy going forward.

Stock Picks

Ascendas REIT (A-RET, BUY, TP S$2.61). 

  • We believe that A-REIT is best positioned to weather the current manufacturing uncertainty. Its portfolio is largely positioned in the business parks, science parks and hi-tech industrial space with accounts for close to 63% of its exposure in Singapore. 
  • Its sponsor, Ascendas-Singbridge, is progressive in its forward planning and has invested in a visible pipeline of industrial properties that can be acquired by the REIT in the medium term.

Mapletree Industrial Trust (MINT, BUY. TP S$1.90). 

  • We believe that there is hidden value in a portfolio with superior location of which a majority of space is located in the central parts of Singapore. While earnings will see a boost upon the progressive completion of HP’s development project come FY17F, the organic outlook remains flattish. 
  • However, we believe that MINT offers longer-term upside in earnings and NAVs from the strategic execution of development projects which will improve the REIT’s portfolio quality and earnings.

Derek TAN DBS Vickers | Melvin SONG CFA DBS Vickers | http://www.dbsvickers.com/ 2016-08-22
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