Singapore REITs Industrial Sub-Sector - Phillip Securities 2017-05-08: Business Parks out, Hi-Tech Buildings in.

Singapore REITs Industrial Sub-Sector - Phillip Securities 2017-05-08: Business Parks out, Hi-Tech Buildings in. Singapore REITs Industrial REIT CACHE LOGISTICS TRUST K2LU.SI KEPPEL DC REIT AJBU.SI MAPLETREE INDUSTRIAL TRUST ME8U.SI SOILBUILD BUSINESS SPACE REIT SV3U.SI

Singapore REITs Industrial Sub-Sector - Business Parks out, Hi-Tech Buildings in.

  • Both sector-wide rental and occupancy were lower q-o-q and y-o-y.
  • Expect sector's aggregate rental reversions to range at negative high-single-digit to negative low-double-digits in 2017.
  • We believe rents could bottom in 2017, but emphasize that negative rental reversions to persist.
  • Key change to our view: Switch from Business Park to Hi-Tech Buildings.
  • Maintaining "Equal Weight" view on Industrial REITs sub-sector on optimism of bottoming of rents this year, while being cognisant of the over-supply situation that is likely to persist into 2018.

What Is The News?

How Do We View This?

Uptick in Industrial activity, signalling improvement in global economy 

  • We first highlighted the initial uptick in 3Q 2016 industrial activity in our report last year (11 November 2016). Since then, PMI has remained in expansionary territory in tandem with Industrial Production which peaked in December 2016. 
  • Industrial Production has since moderated downwards and we would expect both PMI and Industrial Production to converge to more sustainable levels for continued growth.
  • With Singapore being a net-exporter, we are of the view that the higher industrial output has been a reflection of improving global economic sentiment that has been driven by external demand. This is supported by data from The Organisation for Economic Co-operation and Development (OECD).
  • While higher external demand could lead to higher demand for Industrial space, upcoming new supply is still higher than historical supply, and demand is still lower than historical demand.

Continued pressure due to mismatch in supply and demand 

  • Notwithstanding the improvement in Industrial activity, JTC expects about 2.0 million sqm of industrial space to come on-stream in the remainder of 2017. This is about 4.3% of current available stock. 
  • The additional space coming on-stream is significantly higher than the average annual supply of around 1.8 million sqm in the past three years. 
  • Historical average demand over the past three years was 1.3 million sqm.

1Q 2017 aggregate reversions maintained at negative double-digits 

  • 1Q 2017 Rental Index (93.0) is lower than three years ago in 1Q 2014 (105.3). What this means is that lease renewals signed in 1Q 2017 were at lower rents compared to three years ago, and implying negative reversions of -11.7% in aggregate. 
  • We are expecting reversions to range between negative high-single-digit and negative low-double-digits for the remainder of 2017. 
  • Negative high-single-digit reversions would be contingent on a bottoming/stabilisation of rental level this year.

Oversupply in Multiple-User Factory space to persist in 2017 

  • Planned supply of Factory space of 1.52 million sqm for 2017 is about 49% more than the net new supply of 1.02 million sqm in 2016. For Multi-User Factory, planned supply of 549,000 sqm in 2017 is 134% more than the net new supply of 235,000 sqm in 2016.
  • Planned supply of Multi-User Factory in 2017 will add 5.2% to existing stock as at 4Q 2016, compared to the 2.2% added during 2016. Aggregate rental reversion for MultiUser Factory was -13.5% in 1Q 2017 and we are of the view that rental reversions will continue to be negative double-digit for the remainder of 2017.

Supply pressure in 2017 for Warehouse is going to be worse than 2016 

  • Total planned supply for 2017 is 942,000 sqm, which is 61% higher than the net new supply of 584,000 sqm in 2016. Planned supply for 2017 represents 10% additional space to existing stock as at 4Q 2016, compared to the 6.6% that was added during 2016. We are expecting negative high-single-digit rental reversions in 2017.
  • Warehouse occupancy has improved quarter-on-quarter (q-o-q) for three consecutive quarters and the Logistics industry was one industry the CFFE identified to have its own Industry Transformation Map (ITM).

Stale thesis on Business Parks, due to narrowing price-gap with Office rents 

  • Consensus favourite has been Business Park assets. While there is limited new supply in 2017 and 2018 and no new supply in 2019 onwards, we do not expect a significant upward trajectory in rent. 
  • Instead, we expect Business Park rent and occupancy to remain stable q-o-q for the year ahead. With the new supply of Office space coming on-stream, Office rent is expected to ease further, thereby negating the impetus of qualifying tenants to shift to Business Park spaces.

Strategic top-down view

Equal Weight on the Industrial S-REITs sub-sector on optimism of bottoming of rents 

  • We expect the demand-supply imbalance to persist in 2017. Although this would apply downward pressure on rents, but we already see some stabilisation of asking rents and this could indicate the bottoming of rents. However, we emphasize the distinction between negative rental reversions and bottoming of rents. 
  • We expect to still see aggregate negative reversions in 2017. 

Tactical bottom-up view

Switch out of Business Park spaces to Hi-Tech assets: MINT is our preferred choice 

  • The manager of MINT has demonstrated the ability to organically grow the Hi-Tech Buildings segment of the portfolio with the HP BTS project, AEI at 30A Kallang Place and the recently announced BTS data centre. 
  • In addition MINT's Flatted Factories segment which contributes 46% of portfolio NPI has remained stable and maintained 75% tenant retention in 4Q FY17. MINT has achieved low-single-digit positive rental reversions in all four quarters of FY17 for its Flatted Factories segment. 
  • New supply for factory space is generally at Tuas, which is not in direct competition to MINT's portfolio of Flatted Factories which are located in the central regions, such as Toa Payoh North, Tanglin Halt, Redhill and Tiong Bahru. 

Review of Performance Measures of Industrial S-REITs

  • Average occupancy of 93.9% among the Industrial S-REITs was higher than the JTC sector- wide occupancy of 89.4%. 

Key takeaways from the quarter 

Negative reversions appears to be abating, with some hits and misses 

  • Ascendas REIT (A-REIT) reported a positive weighted average rental reversion of +3.2% for its Singapore portfolio during the quarter. However, logistics & distribution centres in A-REIT's portfolio had a whopping -18.8% reversion. 
  • Keppel DC REIT (KDCREIT) managed to renew a colocation lease in a SGP DC at a marginally higher rate than previous. 
  • Soilbuild Business Space REIT (SBREIT) eked out +3.6% reversions on a portfolio weighted average basis (but -6.0% reversion on forward renewals), after a few quarters of negative reversions. 
  • Mapletree Industrial Trust (MINT) was a casualty this quarter, reporting a portfolio weighted reversion of -0.2%, weighed down by Stack-Up/Ramp-Up Buildings segment.

Key change to our view: Switch from Business Park to Hi-Tech Buildings 

  • We now view Business Park space less favourably, as the rental-gap between conventional Offices is narrowing due to over-supply of Office space. We are recommending to switch from Business Park space to Hi-Tech properties for growth, and maintaining exposure to conventional factory for stability. 
  • The Committee on the Future Economy (CFE), outlines manufacturing will continue contributing 20% of gross domestic product (GDP) over the medium term (19.6% in 2016). Hi-Tech properties should benefit from the CFE's skill-up strategy of moving up the manufacturing value chain. 
  • Small and medium enterprises (SMEs) are still the backbone of the manufacturing sector and Flatted Factories (conventional factory) are the bedrock of the manufacturing sector, as it provides affordable accommodation costs to SMEs.

Investment Actions 

  • We are maintaining our "Equal Weight" view on the Industrial sub-sector, on optimism of the bottoming of Industrial rents this year, while being cognisant of the over-supply situation that is likely to persist into 2018. 
  • After our out-of-consensus call from our last report (Possibility of Rents Bottoming This Year - 20 February 2017), the Street has noticeably moved in line and turned upbeat on the Industrial sub-sector as well. 

Cache Logistics Trust (Cache) – High gearing of 43.1% is the key idiosyncratic impediment to inorganic growth 

  • "Reduce" rating from our results report on 21 April - Cache Logistics Trust - Soft DPU Boosted by Capital Distribution
  • Limited scope for organic growth in gross revenue due to oversupply, mitigated by only 4.7% expiry by gross rental income in FY17 
  • Ongoing rental dispute with Schenker at 51 Alps Avenue remains unresolved 
  • Master lease expiry of CWT Commodity Hub in 2018 is a concern with upcoming supply of warehouse space 
  • We forecast 6.69/7.00 cents distribution per unit (DPU) for FY17e/FY18e, which is 8%/4% lower than consensus expectation of 7.3/7.3 cents 

Keppel DC REIT (KDCREIT) – Expecting 32% year-on-year (y-o-y) higher gross revenue and 7.7% higher DPU in FY17e, driven by two acquisitions completed in FY16 and one in January 2017 

  • "Neutral" rating from our results report on 18 April - Keppel DC REIT - Acquisition-driven Growth, Core Results In Line
  • We forecast 6.61/6.04 cents DPU for FY17e/FY18e, which is 8%/18% lower than consensus expectation of 7.2/7.4 cents 
  • Our FY18e DPU is lower than FY17e as we have assumed an equity fund raising associated with the acquisition of the mainCubes data centre in 3Q FY18e Resultant FY18e weighted average unit base is 2.8% larger than FY17e 

Mapletree Industrial Trust (MINT) – Growth from Hi-Tech Buildings 

  • "Neutral" rating from our results report on 26 April - Mapletree Industrial Trust - Hi-Tech Buildings Driving Growth
  • Steady addition of Hi-Tech Buildings to portfolio from 13% (4Q FY14) to 25% (4Q FY17) by net property income Hi-Tech Buildings pipeline: 
    1. Phase Two of Hewlett-Packard (HP) build-to-suit (BTS) to contribute by 2Q CY17, 
    2. 30A Kallang Place asset enhancement initiative (AEI) completing in 1Q CY18 and 
    3. recently announced BTS data centre to contribute by 2H CY18 
  • Growth potential currently priced in; look to accumulate on temporary price weakness 
  • We forecast 11.29/12.00 cents DPU for FY18e/FY19e, which is 4%/3% lower than consensus expectation of 11.8/12.4 cents 

Soilbuild Business Space REIT (SBREIT) – Drag from weaker than expected take-up rate at Loyang Way property 

  • "Neutral" rating from our results report on 13 April - Soilbuild Business Space REIT - DPU impacted by larger unit base
  • Acquisition of Bukit Batok Connection will help to cushion the negative effect of the Loyang Way vacancy; Loyang Way property size is 5.2% by portfolio value 
  • However, DPU will be weighed down by the higher unit base arising from the 1-for-10 Preferential Offering in September 2016 
  • We are expecting lower y-o-y DPU in all four quarters of FY17e 
  • We forecast 5.34/4.76 cents DPU for FY17e/FY18e; this is 3%/10% lower than consensus expectation of 5.5/5.3 cents

Richard Leow cFTE Phillip Securities | 2017-05-08
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