S-REITs & Property - CIMB Research 2017-07-17: Outlook ~ Overweight Developers, S-REITs Down to Neutral


Property - Overall - Focus On Replacement Cost And Spot Rents

  • Looking ahead, we advocate investors to continue buying into developers as we maintain our Overweight stance with catalysts coming from inventory restocking and balance sheet deployment. 
  • We would be selective on S-REITs as we lower our call to Neutral for the sector, on fair valuations following the recent run-up in S-REITs’ share prices.
  • Top sector picks are UOL, City Dev, Capitaland and Wing Tai for developers and FLT, MCT and MAGIC for S-REITs 

Keeping a keen eye of land replacement cost and asset recycling 

  • We anticipate developers to continue to benefit from profit recognition from locked-in presales in Singapore and overseas operations. In addition, we believe capital recycling from asset sales and purchases should provide additional earnings momentum. 
  • We expect investors to continue to focus on the pace and cost of landbank replenishment to drive forward RNAV accretion, with capital recycling and corporate exercises to deploy balance sheet capacity to drive share price performances.

Uneven sub-sector recovery, office rents showing positive signs 

  • We believe investors would be monitoring the pace of recovery in office spot rents, as a potential sub-sector catalyst. We expect retail rental growth to remain anaemic while industrial and hospitality REITs would likely continue to battle supply headwinds. 
  • On the whole, we have raised our target prices for the S-REITs by 1.8-6.9% as we lower our risk-free rate assumption to 2.5%. However, in view of the uneven sub-sector recovery, our order of preference is office, industrial, retail and hospitality.

Outlook – Overweight Developers, S-REITs Down to Neutral 

  • In the section below, we reiterate our Overweight outlook on developers but lower our call on S-REITs from a tactical Overweight to Neutral, given the recent outperformance of the latter.
  • We continue to opine that developers would likely continue to outperform SREITs.
  • Supply across all property sub-sectors in Singapore has turned more manageable, and improving sentiment and demand will underpin the upbeat outlook for developers. Catalysts for developers remain rising replacement cost of new land bank and potential corporate exercises and asset recycling to deploy balance sheet capacity.
  • However, given the prospect of modestly but consistently rising interest rates, amid strengthening economic outlook in the US, S-REITs’ near-term performance may take a breather, in our view.

Residential – Setting the stage for a price recovery 

  • The Urban Redevelopment Authority (URA) Property Price Index (PPI) 2Q17 flash estimate recorded a 0.3% qoq decline, representing 15 quarters of price correction and representing an 11.8% correction from the peak in 3Q13.
  • Housing and Development Board (HDB) resale prices also dipped 0.1% qoq and are now 10.5% below the peak in 2Q13. The dwindling price trend was accompanied by a weaker rental market, even as vacancy remained at 8.1% (as at 1Q17).
  • That said, we note that volume transactions in both the primary and secondary markets have been improving since early 2016. This is in part driven by good take-up rates at new launches following the government’s revision of Sellers’ Stamp Duty period from four years to three years. In addition, we note an increase in foreign buying interest after the multi-year price decline, especially in the high-end market.
  • Meanwhile, the upcoming new housing inventory is scheduled to contract as the oversupply situation normalises. Over 2017-2020, average private home completion is expected to be c.10,073 units while an average of 21,000 public housing apartments are expected to be completed annually, in our view.

Replacement cost is key 

  • With dwindling development inventory, developers have been more actively replacing their landholdings. The land market has heated up – the latest land tender for Woodleigh Lane site was won by the Chip Eng Seng/Heeton/KSH consortium at S$1,110psf ppr (above market expectations of S$750-830psf ppr) and was hotly contested by 15 bidders. This land price implies an estimated end-selling price of S$1,800psf, much higher than the current transacted prices of S$1,500-1,600psf in that area.
  • The government has increased the supply of land in its 2H17 land sale programme to provide 8,125 housing units vs. 7,465 units in 1H17. Nonetheless, this potential capacity is likely to be felt only 4-5 years from now, when the land parcels are sold and developed. In the meantime, new supply is likely to dip; this is likely to provide support to residential prices, in our view.
  • The higher land replacement cost could have two knock-on effects on the residential market. For one, the higher total development cost would mean a higher end-selling price for developers to maintain their development margins.
  • Secondly, earlier concerns of Additional Buyers’ Stamp Duty (ABSD) payments raising land costs for existing projects have been alleviated as comparable land prices on new projects have also gone up.
  • From the demand perspective, studies conducted by MAS indicate that household balance sheet remains robust with the Total Debt Service Ratio (TDSR) well below the 60% ceiling as at 2015. Our assessment shows that this ratio has likely to have improved further in 2016.
  • Our sensitivity study also showed that every 100bp hike in mortgage lending rates (beyond the 3.5% used for TDSR assessment) would result in a 3.5-4% pt hike in TDSR ratio, but still remaining well within the regulatory levels. A 10% hike in residential values could also translate to a 3-3.5% pt rise in TDSR ratio.
  • Hence, we think a portion of home buyers would still be able to afford property purchases in the event of price appreciation.

Boosting balance sheet productivity 

  • In recent months, in addition to land banking and asset acquisitions, we note a slew of corporate moves by developers brought about by a valuation gap between equity values and physical market values. These, including the proposal by Wing Tai Holdings to take its Malaysian subsidiary Wing Tai Malaysia private at a discount to book value, will likely enable the group to recognise a hefty negative goodwill and lift earnings from reducing minority leakage, when completed. 
  • In addition, UOL’s proposed share swap of UIC shares with Haw Par will raise its stake in UIC to just below 49% and also enable UOL to consolidate UIC’s earnings. The most recent is the proposed takeover by the PREH/Yanlord consortium of United Engineers (UEL)
  • We believe as developers’ balance sheets remain under-utilised and the need to redeploy capital arises, asset acquisitions and corporate exercises are likely to remain visible.

S-REITs – Downgrade to Neutral 

  • We downgrade S-REITs from a tactical overweight to Neutral. Valuations have normalised in tandem with the flattening of the yield curve, and prospects of a gradually rising interest rate would likely cap near-term share price performance.
  • S-REITs had done well in 2Q on the back of the flattening of the yield curve and attractive dividend yields. However, valuations have normalised with the sector now trading at a forward yield of c.6.3% and 1.04x P/BV. This implies a 420bp spread over the 10-year bond yield.
  • Looking ahead, the interest rate is expected to gradually rise with the US economy on a firmer footing, anchored by a stronger labour market and declining deflationary risks as global growth picks up.
  • Our CIMB Private Bank economist Song Seng Wun indicated that “…the likelihood of significantly tighter US and Eurozone monetary policies over the coming 12-15 months is still low although complacent long positions have been shaken out of the global bond market by the latest mini taper tantrums. Although deflation risks had largely vanished as global growth picks up pace, European policymakers made clear there were no imminent plans to scale back the aggressive easing implemented over two years ago because of uneven growth across the EU.
  • In the US, the economy is on firmer footing anchored by stronger labour market conditions. Therefore, the US Fed is in a more confident mood, saying it is ready to start reducing its US$4.5 trillion asset portfolio within months after hiking its fed fund rates four times over the past three years. However, the “normalisation” of the Feb’s balance sheet will be calibrated and the impact on financial markets is expected to be limited, according to the minutes from the Jun Federal Open Market Committee (FOMC) meeting. 
  • Looking ahead, we expect central banks' moves on interest rates, including withdrawing of stimulus, to continue to be data dependent. At this juncture, the macro data sets from the US and Eurozone are still supportive of a gradual interest rate hike trajectory: US fed funds are likely to be hiked one more time before year-end, and three times in 2018, taking the benchmark rate to 2.1% by end-2018 vs. a projected 1.4% at end-2017, according to the latest Fed forecast……” 
  • In the section below, we also take this opportunity to relook at our target prices and recommendations of S-REITs following the recent share price run-up, even as we tweak our earlier Singapore risk-free rate assumption to 2.5% (2.8% previously) due to a flatter-than-projected yield curve, and also reassess our rental growth projections. Accordingly, across the board, our target prices have been raised by 1.8-6.9%. 
  • Also, owing to the recent outperformance, we downgrade our recommendation for CRT from Add to Hold. We also lower our call on KDC REIT from Add to Hold post its 2Q17 results with a slightly lower TP of S$1.28. From a total returns perspective, our top picks in the S-REIT sector are FLT, MCT and MAGIC.

Capital management 

  • As at end-Jun 17, we estimate that the S-REIT sector had an average gearing of 36%. Given the limited movement in the short- to medium-term rates over the past 3-4 months, we estimate that the average cost of debt for the sector remain fairly flat qoq. Due to the prospects of rising interest rates, S-REITs such as ART, OUECT and CDREIT undertook pre-emptive rights issues to pare down debt and fund new purchases while FLT conducted a share placement to fund its acquisition. This will keep gearing well within the required 45% limit.
  • S-REITs have also locked in 70-80% of their funding costs. Hence, any hike in near term interest rates is not likely to impact DPU materially, in our view.

Data points to watch out for 

  • In terms of sub-sector preferences, we rank office, residential, industrial, retail and hospitality, in this order of preference.

Office – earlier-than-expected rental recovery 

  • According to property consultants Jones Lang Lasalle and Cushman & Wakefield, Singapore office rents bottomed out in 2Q and saw their first uptick in nine quarters. This is earlier than our expectation of a late-2017 recovery. While average rents are still lower than the levels seen three years back, we believe market watchers would be monitoring the speed of closure of this rental gap. 
  • We maintain our expectation of a 5-10% rental correction this year, for now.


  • The sentiment in the industrial sub-sector has improved with the upbeat manufacturing data, with the manufacturing sector notching its 9th month of consecutive expansion. JTC multi-user and warehouse rental index fell 1% and 0.5% in 1Q17. Industrial players have been in an acquisition mode to lengthen the underlying land lease of their portfolios and boost income yields, and we expect this to continue.
  • Amongst the various industrial sub-sectors, we remain more upbeat on the business parks space given the lack of new incoming supply from 2019 onwards.
  • We believe this will be supportive of business parks’ rents, and project rents to improve by 0-5% in 2018.


  • The URA retail rental index fell 3% qoq and 10.2% yoy in 1Q17 while vacancy rose to 7.7% during the quarter. Meanwhile, seasonally adjusted retail sales (excluding motor vehicle sales) continue to be anaemic, rising 4.9% yoy in April.
  • With average occupancy cost ranging between 16% and 18%, modest retail sales growth and structural cost competition from e-commerce, we think the capacity to push rents will likely remain limited. Hence, we project only a slight uptick in rents in the medium term. 
  • Although the overall retail rental index continues to slide, we believe retail REITs which are better managed would likely continue to see modest rental growth through active mall management and asset enhancement initiatives.  


  • The latest 1Q17 Singapore Tourism Board (STB) statistics showed that visitor arrivals grew 4% yoy, after expanding 2% in 2016. The overall hotel industry showed a 0.4% yoy improvement in Revpar, with luxury hotels seeing a better 5% improvement and mid-tier hotels a 4.1% decline. 
  • Given the projected 5-6% increase in room supply this year vs. our projection of a 2% increase in tourist arrivals, we expect Revpar to recover only from 2H18 onwards.

Top Developer and S-REIT picks 

  • Our top picks amongst developers are UOL, City Dev and Capitaland; we have moved Wing Tai to our sector top picks list as we believe investors have not fully priced in the benefits of Wing Tai Malaysia being taken private, a process currently ongoing. 
  • In the SREITs space, we continue to like FLT for its growth prospects, underpinned by recent asset acquisitions and robust fundamentals in Australia. We like MCT for its growth from MBC, and maintain Add on MAGIC on expectations of better HK retail performance.

LOCK Mun Yee CIMB Research | YEO Zhi Bin CIMB Research | http://research.itradecimb.com/ 2017-07-17
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