REITS - CIMB Research 2016-12-05: Underweight, Inputting Higher Rates

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Singapore REITs Sector Outlook

REITS - Underweight, Inputting Higher Rates

Downgrade from Overweight to Underweight 

• We downgrade the sector from Overweight to Underweight. The rising of yields and steepening of curves would cap share price performance while DPUs would also be slightly affected on higher refinancing costs. 
• The sector is trading at trailing dividend yield of 6.8% (vs. average of 6.3%); and 0.93x P/BV (vs. average of 1.04x). In addition, the sector is trading at a 450bp spread over the 10-year bond yield (vs. long-term average of 370bp and average of 420bp post-2010). 
• We read that the market has probably priced in 1-2 rate hikes for (vs. our expectation of three hikes). Also, growth expectation for 2017 is even more muted vs. 2016 as negative rental reversions pass through.
• Meanwhile, the CIMB fixed income research team has forecasted a 2-year US Treasury rate of 1.5% (currently 1%) and 10-year Treasury rate of 2.75-3% (currently 2.35%) for 2017. The team sees the possibility of one FOMC hike in 1H17 and another probable two in 2H17.
• Accordingly, we have, across the board, raised our Singapore risk-free rate (Rf) from 2.2% to 2.8% (based on four-rolling forward quarters). As a result, our target prices have been cut by 4-12%. 
• Also, owing to relative outperformance post-Trump, we have downgraded CCT, CDREIT, KDCREIT, and MCT from Add to Hold respectively. We have also downgraded SUN from Hold to Reduce.
• Otherwise, our DPU forecasts are intact. Based on total return, our top picks are now FCT, MINT and PREIT.
• Looking to the 12-month forward DPU growth, we project hospitality sub-sector to have 3.3% yoy growth due to low-base effect and bottoming of RevPAR; office to derive 0.2% yoy growth as we expect the sector to bottom out; 0.2% yoy decline for retail as the operating environment continues to deteriorate; and 0.8% yoy decrease for industrial owing to weaker leasing demand and multi-tenanted building (MTB) conversions. That said, we note the divergence in fortunes between the big-cap and small-cap names.  

Capital management 

• A rising rate environment requires sound capital management. As at 9M16, the sector had a total debt of S$43.8bn with debt maturity of four years, backed by AUM of S$115.3bn. 
• Sector gearing stood at an average of 36%, with a weighted cost of debt of 2.7%. About S$3.8bn of debt (or about 9% of total debt) is due for refinancing in FY17. This refinancing portion would most likely experience higher borrowing plus hedging costs. 
• Anecdotally, we understand that hedging cost could be c.100bp higher than preceding level. REITs which have more than 30% of their debt due for refinancing in or up to FY17 include ASCHT, CRCT, FEHT, FIRT and LMRT.
• In addition, REITs which have gearing above 40% include ART, CACHE, IREIT, SSREIT and OUECT. Assuming a 5% devaluation in AUM (owing to an expansion in cap rate), the gearings of KREIT, MAGIC, PREIT and VIT respectively would also cross 40%. Taking it further, 10% devaluation in AUM would, on top of the above, result in the gearings of CCT, CDREIT, CRCT, FHT, MCT, MLT, OUEHT and SUN to cross 40% respectively.
• On the other hand, the impact of the Fed raising rate on DPU is relatively muted as c.80% of borrowings is hedged against interest rate. We estimate that a 50bp rise in interest rate could shave off 0-2.9% of the REIT’s distributable income. CRCT, with 53% of debt hedged against interest rate, is the most sensitive, followed by KREIT (74% hedged) and OUECT (78% hedged). 
• AIT, CRT and MUST are fully hedged against the interest rate.

1H data points to watch out for 

• With the market pricing in one rate hike in 1H17 – and that apparently, a forgone conclusion – we would watch for 
  1. quarterly momentum in spot rates, 
  2. the extent of rental reversions, and 
  3. leasing activities/occupancy 
  to take cue of whether a better demand-supply equilibrium could be achieved towards year-end. 
• Supply for both office and hotel are expected to ease post-17. We would be watchful for valuation cap rate.

2H data points to watch out for 

• With the market decidedly mixed on the extent of rate hikes, we would zoom out and focus on macro in the 2H.

Office outlook: supply crisis passing but low growth drag on rents 

• The office sector continues to experience rental decline, with a 1.1% decline qoq in 3Q16 and 13.2% erosion since the beginning of 2015. In terms of capital values, prices have fallen by a milder 2.5% since 2Q15. However, net absorption was a marginal 280,000 sq ft for 9M16 despite a net addition of 1.13m sq ft of new office inventory. As a result, vacancy levels dipped to 10.4%, the highest since 2Q12. Major office space consumers include IT, telecom and financial services.
• Looking ahead, a sub-par GDP growth plus an additional supply of 2.9m sq ft in 2017 would likely continue to pressure rental outlook in the near term. Demand is closely correlated with GDP. Although pre-commitment levels for the majority of new supply has been encouraging, we understand the bulk of this came from replacement demand with a marginal increment in new appetite.
• Beyond 2017, new supply will be fairly muted, with supply tapering down to c.1m sq ft p.a., in tandem with the long term annual absorption. Hence, we think that the downward rental momentum could decelerate going into 2H17. In terms of capital values, we think that the recent land bid for the Central Boulevard site has injected some optimism in the future projections for the office rents and capital values. We expect office rents to decline by 0-5% in 2017. In terms of rental reversions, commercial S-REITs are likely to see greater negative renewals in 2017 vs. a year ago.

Retail outlook: anaemic growth outlook 

• Retail sales (excluding motor vehicles) continued to decline in Sep 16, contracting 1.9% yoy. This represents the 8th month of yoy decline since the beginning of the year. The drag was felt in the department stores, supermarkets, F&B, apparel and footwear, watches and jewellery and IT and telco segments. Despite higher tourist shopping spend in 1H16, we think weaker consumer sentiment amid a slower economic outlook and leakage from growing e-commerce sales eroded purchasing behaviour.
• Based on URA indices, retail rents have retraced 7% for 9M16 and down 11% from the peak at end-2014. Meanwhile capital values have contracted 5.6% for 9M16 and 6.4% lower than the end-2014 level. However, for selected REITs, active property management and niche locations such as MCT’s Vivocity and FCT’s Causeway Point have held up better, with positive rental reversions.
• Looking ahead, annual new supply of 1.2m-1.8m sq ft is higher than the annual average demand of 700,000sq ft since 2011. The bulk of the new supply is located in the city fringe and suburban areas such as Singpost Mall (2017), Paya Lebar Quarter (2018), Northpoint City (2018) and The Heart (within Marina One) and Downtown Gallery in the CBD area in 2017. The positive flipside is that supply is well spread to locations that are under-served, particularly in the suburban and city fringe areas.
• In tandem with the slower GDP growth forecasts of 1-3% for 2017 as well as our expectation that tourist arrivals growth would moderate to 2-3% from the 7- 8% this year, we project retail rents and capital values to remain flat.
• From the retail S-REITs perspective, we think that rental improvement upon reversion will continue to moderate from the present 2-9% to 0-3% as slowing retail sales cap ability to raise rents.

Industrial outlook: near-term pressures on business parks 

• As at 3Q16, Singapore had a total of 493m sq ft of industrial stock. Single-user factories formed the majority at around 52%, followed by multiple-user factories (23%), warehouses (21%) and business parks (5%). Among these asset class, warehouses face the highest supply (8.8% of total stock is to be completed between now and 2018), followed by multiple-user factories (7.3%) and business parks (1.2%).
• While consensus has trumpeted the positivity of business parks, we are more cautious in the near-term (especially for business parks ex-city fringe). As a result of peak supply for 2016 (notable completions include Ascent at the Singapore Science Park and Mapletree Business City II), island-wide occupancy is expected to fall to 80.2% in 2016 (2015: 84.1%). We expect occupancy to recover to 85.2% in 2017 and to 90.2% in 2018. Hence, we believe that business park rents would strengthen from current median rate of S$4.25 psf pm from 2H17/18 onwards.
• In the meantime, we expect occupancy for warehouses to drop to 86-88% for 2017-18 (2015: 91.4%). 2017 is set to be another strong year of completions and we expect warehouse median rent to decrease by another 5% pts in the next 12 months (3Q16 rent index at 91.2).
• We expect occupancy for multiple-user factories to remain in the range of 87% for 2017-18. We expect multiple-user factory median rent to moderate by another 3-5% to S$1.75-1.78 psf pm in the next 12 months.

Hospitality outlook: expect 2.8% yoy decline in RevPAR 

• For 2017, we now expect 3,637 rooms to be added to the estimated room inventory of 63,428 (as at end-16), representing 5.7% of total rooms.
• Completions have been pushed from 2016 to 2017. We now expect 2,520 rooms to be added in 2016 (previously 3,319).
• We also foresee higher supply pressures for the upscale/luxury segment as 47% of the additional room supply in 2017 is from this segment. Examples include Andaz Singapore, Novotel Singapore on Stevens, InterContinental Singapore Robertson Quay and Sofitel Singapore City Centre. In addition, supply is skewed slightly towards the end of the year. The swing factor is the opening of the 610-room YOTEL Orchard (the chain of economy micro-hotels) which we have penciled in towards the end of 2017. Excluding this, supply looks fairly spread out.
• On the demand side, we have conservatively factored in a 2% yoy growth in visitor arrivals to 16.6m in 2017 (expect Chinese arrivals to flatten and odd-year effect). We have assumed a 7% yoy growth in visitor arrivals to 16.3m for 2016.
• In all, our demand-supply model predicts a 2.8% yoy decrease in RevPAR for 2017. For 9M16, the industry RevPAR decreased 2.1% yoy to S$201 on the back of a 6.4% yoy increase in available room nights.

Risks 

• Risks to our Underweight position are a more dovish-than-expected Fed stance and better-than-expected net absorption of supply.

YEO Zhi Bin CIMB Research | http://research.itradecimb.com/ 2016-12-05

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