Singapore REITs - OCBC Investment 2016-08-23: Staying Positive On S-REITs


Singapore REITs - Staying Positive On S-REITs

  • Flattish 2QCY16 performance.
  • Weakness in industrial and hospitality sectors.
  • Interest rate environment to remain accommodative. 

2QCY16 results largely met expectations 

  • During the recently concluded 2QCY16 earnings season, out of the 23 SREITs under OCBC Investment Research’s (OIR) coverage, only OUE Hospitality Trust and Ascott Residence Trust (after stripping out a one-off gain) reported results which fell short of our expectations. The remaining 21 REITs met our expectations. 
  • Overall DPU growth for these REITs was flat (-0.1%) on a YoY basis, despite decent growth in net property income (+8.2% YoY) and distributable income (+5.2%). This can be attributed to the regular issuance of new units as partial/full payment of management fees, coupled with REITs which have recently carried out equity fund raising exercises.
  • The notable strong performers came from OUE Commercial Trust (OUECT), Lippo Malls Indonesia Retail Trust and Mapletree Greater China Commercial Trust, which registered YoY DPU growth of 34.7%, 16.4% and 9.1%, respectively. For OUECT, it should be noted that the huge jump in DPU was attributed to the dilution caused by a rights issue in 2Q15 before the One Raffles Place acquisition kicked in.

Hospitality and industrial REITs remained as the weaker performers 

  • Similar to previous quarter’s trend, the main drag during the 2QCY16 earnings period came from the hospitality and industrial sectors. For the former, we saw weakness in RevPARs for Singapore hotels and RevPAUs for serviced residences. Most industry players highlighted that June was a particularly poor month. We believe this could be attributed largely to the absence of the SEA Games which took place in June last year.
  • Another key factor for the muted performance was due to weaker demand from the corporate sector, as the uncertain macroeconomic landscape and volatility in oil prices impacted sentiment and resulted in fewer bookings from oil and gas related project groups.
  • For the industrial sector, we note that small-mid cap REITs had a difficult quarter, while the bigger players such as Ascendas REIT and Mapletree Industrial Trust still managed to deliver DPU growth of 4.1% and 4.4%, respectively, as compared to the same period last year. Performance for the office and local retail REITs was relatively stable.

S-REITs sector has been a strong outperformer YTD 

  • Despite the challenging operating environment, the FTSE ST REIT Index (FSTREI) has been one of the best performing indices, turning in a YTD appreciation of 8.7%, versus the STI’s 1.4% dip. Following the surprising UK referendum vote earlier in Jun, investors’ hunger for high quality defensive yield assets grew, as bond yields compressed further in light of the uncertain outlook and continued stimulus measures by central banks.
  • The FSTREI has increased 5.9% since the Brexit vote, outperforming the STI’s 1.7% appreciation during the same period.

FOMC Jul minutes suggest accommodative interest rates ahead 

  • The recently released FOMC Jul meeting minutes showed that members were divided over the urgency to hike rates, as there were expectations that inflation would remain low in the near term, while some officials believed the US labour market conditions were at or close to full employment. Following the release of the minutes, US Treasury yields fell and the USD experienced a pullback. 
  • Based on the fed funds futures rate, the probability of at least one rate hike by the end of the year stands at 51.0%. We believe this supports our thesis that there will be a structural shift towards a prolonged period of accommodative interest rates. The Fed will likely tread carefully as more concrete data points are needed to justify another rate hike given the fragility of the macro environment. 
  • It was also highlighted that the Committee’s view of economic conditions suggests that the fed funds rate will only be raised gradually, and is likely to remain for a period of time below levels that are expected to prevail in the long run.

Relative valuations still attractive 

  • The FSTREI is currently trading at a blended forward distribution yield of 6.4%, while the Singapore Government 10-year bond yield is at 1.8%, implying a yield spread of 463 bps. Compared to the historical trading band, this spread represents 0.3 standard deviations above the 5-year mean of 445 bps. 
  • We believe there is room for the spread to compress further, given our view that the interest rate environment would likely stay benign. 
  • We reiterate our OVERWEIGHT rating on the S-REITs sector, with Frasers Centrepoint Trust [BUY; FV: S$2.32], Keppel DC REIT [BUY; FV: S$1.30] and Ascendas REIT [BUY; FV: S$2.66] as our top picks
  • Given our positive view on the sector, we also add SPH REIT [BUY; FV: S$1.05] and Mapletree Greater China Commercial Trust [BUY; FV: S$1.18] into our preferred picks list.

Retail sector: Still largely resilient 

  • Retail REITs turned in a relatively resilient performance for the 2QCY16 period. Under our coverage, only CapitaLand Retail China Trust recorded negative YoY DPU growth, while other overseas focused retail REITs fared better (Mapletree Greater China Commercial Trust +9.1% YoY; Lippo Malls Indonesia Retail Trust +16.4% YoY). 
  • Occupancy rates and rental reversions largely held up, with only OUE Hospitality Trust’s Mandarin Gallery and Starhill Global REIT’s Wisma Atria (retail) turning in negative rental reversions during the period. Tenants’ sales faced more challenges, given the tepid macroeconomic environment, but we note that gross turnover rents typically form a small percentage of REITs’ overall gross rental income. 
  • We believe the situation at Wisma Atria (retail) could improve ahead, as Isetan’s strata-owned space at the property has progressively reopened for operations after its renovation works since Apr last year. Isetan recently launched Japan Food Town at the mall, a collection of 16 casual dining establishments handpicked from Japan.

Redevelopment/AEI and acquisitions to drive future growth ahead 

  • In order to enhance the sustainability of future returns to unitholders, REIT managers have stepped up efforts to enhance their portfolios. This includes redevelopment works, AEIs and acquisitions. 
  • Frasers Centrepoint Trust’s renovation on Northpoint resulted in the mall’s occupancy dropping from 96.2% (as at 31 Dec 2015) to 81.3% (as at 30 Jun 2016). However, it expects future average gross rental rates to increase ~9% upon completion of the AEI. 
  • CapitaLand Mall Trust has begun the redevelopment of its Funan DigitaLife Mall, whereby the property will comprise three components: retail, office and serviced residences, when completed in 4Q19. Management estimates an incremental NPI per annum of S$36.6m for this project, which translates into a ROI of 6.5%. 
  • Mapletree Commercial Trust (MCT) recently proposed to acquire Mapletree Business City (Phase 1) from its sponsor for a purchase consideration of S$1.78b, to be funded via a combination of debt and equity. This asset will allow MCT to diversify its operations. Management projects DPU accretion of 3.2% for the period from 1 Oct 2016 to 31 Mar 2017, based on its circular.

Office sector: core CBD rents still on the decline 

  • Based on data from property consultant CBRE, core CBD office rental came in at S$9.50 psf/month for 2Q16, down 4.0% QoQ and represented five consecutive quarters of sequential decline. Other downbeat data points include a fourth straight quarter of negative islandwide net absorption, which stood at -74,741 sq ft in 2Q16. Office REITs have continued their proactive approach on their renewal strategies, further bringing down their lease expiry profile for the remainder of 2016 as well as 2017. For example, Suntec REIT had 1.8% and 17.4% of its office leases expiring in 2016 and 2017, as at 30 Jun 2016, versus 6.0% and 19.7% a quarter ago, respectively. Similarly, Keppel REIT has seen its 2016 and 2017 lease expiry profile lowered from 3.2% and 11.5% (as at 31 Mar 2016) to 0.6% and 9.5% (as at 30 Jun 2016).
  • The share prices of office REITs have largely performed well YTD, with CapitaLand Commercial Trust, Keppel REIT and Suntec REIT seeing 15.6%, 15.1% and 9.0% appreciation in their stock value, respectively.
  • However, we remain cautious as the large amount of new office supply draws nearer to completion, while pre-commitment levels continue to be relatively low. This is likely to exert further downward pressure on rents, in our view.

Industrial sector: Soft 2QCY16 performance 

  • Of the nine industrial REITs which we track, six registered lower occupancy rates as at end 2QCY16, versus a quarter ago. Rental reversion figures were also subdued for those which gave disclosures, ranging from -15.8% (Cambridge Industrial Trust) to 4.1% (Ascendas REIT’s Singapore portfolio). According to JTC, the price and rental indices of all industrial properties dipped 2.3% and 1.7% QoQ, respectively, in 2Q16. This was the fifth consecutive quarter of decline for both indices.
  • The business park segment was the only bright spot which saw positive rental growth during the quarter.
  • We believe the outlook ahead remains challenging, given expectations of continued softness in the global economy and manufacturing sector, coupled with looming oversupply concerns
  • On 11 Aug, The Ministry of Trade and Industry narrowed Singapore’s GDP growth forecast to 1%- 2%, from 1%-3% previously. Meanwhile, an estimated 1.6m and 2.0m sq m of industrial space is expected to come into the Singapore market in 2H16 and 2017, respectively. These figures appear ominous when taken in comparison with the average annual supply of 1.8m sq m and average annual demand of 1.2m sq m in the past three years.

Hospitality sector: No signs of bottoming out yet 

  • Judging from the performance of hospitality REITs in 2QCY16, we believe the industry has not shown signs of bottoming out. RevPAR and RevPAU for Singapore hotels and serviced residences were poor, with only Frasers Hospitality Trust showing positive YoY growth. However, this was due to InterContinental Singapore returning to full inventory following its renovation. 
  • Despite continued growth in visitor arrivals to Singapore (Jun +7.1% YoY; positive YoY increase since May last year), this did not translate into similar contribution to hospitality players, as RevPAR for the industry dipped 11.2% YoY to S$179.4 (Jan-Jun 2016 RevPAR down 2.5%). 
  • The hospitality sector continues to be hit by weak corporate demand and competitive pressures arising from new supply introduced to the market. The absence of the SEA Games which took place in June last year also had a negative impact on the sector’s performance.

  • In terms of overseas markets, Australia and Japan fared well, while Malaysia and the UK were soft. Performance of assets in China was mixed, with the first tier cities doing well, but the second tier cities faced more challenges.

Wong Teck Ching Andy CFA OCBC Investment | http://www.ocbcresearch.com/ 2016-08-23
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