Singapore Developers & REITs - DBS Research 2017-01-06: Rocky Road, Take me home

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Singapore Developers & REITs KEPPEL REIT K71U.SI MAPLETREE COMMERCIAL TRUST N2IU.SI FRASERS LOGISTICS & IND TRUST BUOU.SI KEPPEL DC REIT AJBU.SI CROESUS RETAIL TRUST S6NU.SI

Singapore Developers & REITs - Rocky Road, Take me home

• Luxury residential and office sub-sectors to bottom out ahead of other sub-sectors in 2017.
• Diversification remain a key strategy for most real estate companies, cheap valuations could spark M&A.
• Deleveraging trend to kick in from 2017.

Investment Summary 

• 2017 remains a tenants' market as heightened supply completion poses a risk for most real estate sectors. It will be another year of moderation for the Singapore property market as we believe that most real estate subsectors will continue to see downside in rents and/or prices on the back of soft demand given the current economic slowdown. 
• Meanwhile, heightened supply completion in 2017 means that it will remain a tenants' market.

Key Theme 

1. Luxury-end of residential market and office sectors bottoming out 

• Luxury residential and office sectors the brighter spot. However, among the real estate sectors, we see brighter prospects in the luxury end of the residential market and office subsectors. 
• We believe that luxury residential prices in Singapore are attractive on a relative basis compared to home prices in the region which we expect higher investment transaction volumes in 2017. 
• The office sector is projected to see slower rental declines of (5-10%) mainly due to better- than-projected take-up in upcoming new office buildings and see the sector bottoming out by end of 2017.
• However, the retail, hospitality and industrial sectors are still expected to feel the pressure from projected negative net absorption, given excess supply outlook.

2. Developers and REITs to continue seeking overseas opportunities; en-bloc deals to pick up in 2017 

• Diversification remains a key strategy but opportunities limited as currency volatility arises. We believe that property developers and REITs will continue their strategy to diversify overseas for growth but expect the acquisition momentum to taper on the back of increased currency volatility, coupled with higher cost of funds. Countries that we believe remain attractive on a currency-adjusted basis are London, Australia (Melbourne and Sydney) and selected Tier 1 cities of China like Shanghai.
• Apart from acquisitions, REITs could also capitalize on the increased development limits (25% cap vs 10% previously subject to conditions) accorded by Monetary Authority of Singapore (MAS) to take on more asset enhancements to rejuvenate their portfolios and boost returns.
• Developers are hungry for land in Singapore, more en-bloc deals in 2017. We expect continued increased participation from developers in the upcoming first half 2017 government land sales program (GLS) as developers look to replenish diminishing land banks which will mean that land prices are likely to remain firm. In addition, we expect to see more en- bloc deals for opportunities, especially in the luxury end of the market. These activities in our view, likely signal expectations that home prices should remain fairly stable in the coming years.

3. Privatisations, mergers and acquisitions to pick up 

• Privatizations, mergers and acquisitions (M&A) in the developer space to pick up. We believe that more listed property developers will take the delisting route along with the wave of privatizations that we saw in recent years. This puts valuations for property developers again in the spot light. Developers are trading at an attractive average 0.75x P/NAV, close to the -1SD of their historical trading range.
• Reasons that drive this trend could be 
  1. sea of capital looking to deploy in Asian real estate, and 
  2. strategic capital partners or major shareholders looking to recalibrate their strategies given the lacklustre capital markets and thus capturing the upside in the medium term.
• We believe that such M&A activities highlight the attractive valuations of listed developers, namely City Developments, CapitaLand, Global Logistics Properties and UOL which are trading at close to -1 standard deviation (SD) to their 5-year historical trading range.

4. Deleveraging a focus as interest rate risks loom 

• Balance sheet deleveraging a major wildcard; spike in bond expiry in 2017-2018 a key data-point to watch. In view of the uncertainty of the pace of interest rate hikes in 2017, we believe that the early refinancing and hedging of interest rates will be a key focus for developers and REITs going forward. Of noteworthy is close to S$6.3 worth of bonds (S$4.0bn among developers) expiring over 2017-2018 where issuers will need to source for refinancing or alternative means to repay the bonds.
• While we believe that refinancing for REITs are likely to be more straight forward given that credits are backed by consistent recurring cash flows, we believe that certain developers, especially those in the mid-cap space which have been more opportunistic in tapping the bond market in recent years could face more hurdles.
• The recent bond defaults in 2016 among the oil & gas firms have cooled investors’ interest in bonds and we believe that investors will be more selective on the credit for future bond issuances. As such, the inability to refinance these expiring bonds could mean that issuers (developers or REITs) might seek alternative financing sources such as banks or even issuance of equity.

Strategies for: Singapore REITs – Capital preservation a key strategy 

• Projected more hawkish four FED hikes to limit upside performance. We see increasing road-bumps to further outperformance for Singapore REITs (S-REITs) going into 2017, especially faced with a slowing DPU growth profile of 1.0% amidst a rising interest rate environment. 
• DBS economist projects four FED rate hikes over the course of the year and as a result, the Singapore 10-year yield is expected to increase another 0.7% to a normalized c.3.0%. Forward FY17F yield spreads of 4.0% are already at historical mean levels which indicate that valuations for REITs are fair.

Capital preservation is key. 

• In an environment of low growth and rising interest rates, we believe that investors will look at stock-specific catalysts to maintain relative outperformance with the sector. These are S-REITs that provide 
  1. higher confidence in earnings sustainability and visibility, 
  2. stronger relative growth, and 
  3. lower gearing which limits impact of rising rates on distributions.
• Our picks are Ascendas REIT (A-REIT), Keppel REIT (K-REIT), and Mapletree Commercial Trust (MCT). 
• Among the mid-cap space, we like Croesus Retail Trust (CRT) , Keppel DC REIT (KDC REIT) and Frasers Logistics Trust (FLT).

Strategies for: Singapore Developers – Catalysts abound to re-rate 

• Potential policy relaxation and M&A could lift sentiment on developer stocks. Our call on the developers is mainly due to valuations supported by an improved outlook. 
• Firstly, we view current trading levels of (P/Bk NAV of 0.75 and 0.65x P/RNAV) as attractive given that developers are trading at close to historical -1SD level. 
• We believe that re-rating opportunities will come from the following data-points: 
  1. improved sell-through rates for existing developments on the back of improved transaction momentum, 
  2. potential relaxation of selective government policy in 2017 driving higher demand for homes and investors’ sentiment, and 
  3. potential privatization, M&A activities among developers or value-locking events like asset divestments which will provide a lift for NAVs and thus share prices for developers. 
• Our picks are City Developments and UOL.

Risks 

1. Faster-than-projected rise in shorter-term interest rates which will negatively impact earnings and potentially capital values in the medium term.
2. External shocks impacting on GDP outlook and unemployment rates in Singapore which will have an overhang on demand/supply dynamics.

Derek TAN DBS Vickers | Mervin SONG CFA DBS Vickers | Rachel TAN DBS Vickers | http://www.dbsvickers.com/ 2017-01-06

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