S-REITs Pulsebeat - RHB Invest 2018-05-16: Banking On Growth Outlook

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Singapore REITs SREITs Debt Profile ASCENDAS REAL ESTATE INV TRUST SGX: A17U OUE HOSPITALITY TRUST SGX: SK7 CDL HOSPITALITY TRUSTS SGX: J85

REITs Pulsebeat - Banking On Growth Outlook

• Maintain OVERWEIGHT. 
• We remain cautiously optimistic on the S-REIT sector’s prospects despite market concerns over rising interest rates. Key reason is the improving market outlook for REITs, with a broad-based demand pick- up and supply tapering across most sub-segments.
• On the balance sheet-front, REITs are generally well-prepared; ~80% of debts are hedged to mitigate rising interest costs.
• Many have also started exploring new markets in their quest to deliver inorganic growth and diversify their presence. Among the sub-sectors, our preference is for hospitality and industrial REITs – we believe they are well-poised to tap into demand growth.

Promising growth outlook mitigates rate hike threats.

• S-REITs are currently trading at a 330bps spread to the Monetary Authority of Singapore (MAS) 10- year bond yield. By comparison, the 10-year average mean spread stands at 410bps – excluding the Global Financial Crisis (GFC) peaks. 
• While the threat of rate hikes in general pose a threat for yield instruments, we believe S-REITs are relatively in a better position as:
  1. Improving economic conditions have resulted in a better demand outlook for REITs, which should filter down to DPU growth;
  2. The oversupply threat, which weighed across S-REITs over last few years, are beginning to fade away;
  3. REITs are also expected to deliver inorganic growth from recent acquisitions, and balance sheet positions remain strong.
• Thus, we continue to believe that S-REITs are well-positioned to capture this uptrend and outperform their peers. 
• Overall, we expect the S-REIT stocks under our coverage to deliver DPU growth of 2% for 2018, with the hospitality REITs (4% y-o-y DPU growth) and industrial REITs (3% y-o-y DPU growth) sub-sectors being key contributors.

Our analysis of REITs’ debt profiles

• Our analysis of REIT's debt profiles show that most of the REITs are well-prepared for the current rate hike in this cycle when compared to the past. On an average, close to 80% of REITs are currently hedged, with only a minimal 9% of debts expiring this year. 
• S-REITs’ average gearing also currently stands at the 35% level, which is well below the maximum allowable threshold of 45%. Thus, we do not expect REIT interest cost expenses to rise up drastically in the near term.

Key takeaways from recent management briefings.

• Across all sectors, REIT management teams expressed cautious optimism on the outlook for 2018. Demand growth was seen across all sub-segments. Most of the REITs also highlighted that borrowing costs have inched up, with 20-50bps hike seen over the last two quarters.
• With cap rate compression still in play in Singapore and Australia, many REITs also indicated their plans to explore new geographies. This includes the US and Europe. 
• On the capital structure front, more REITs are exploring the addition of perpetual securities as a mode of fundraising – this is in order to avoid breaching gearing thresholds. Additionally, many REITs have also activated dividend reinvestment programme (DRP) schemes to boost their equity bases.

Sector Outlook Summary

Industrial REITs – positive demand outlook amid tapering demand.

• Based on the Economic Development Board’s (EDB) latest business sentiment survey (April), all clusters within the manufacturing sector are anticipating better business prospects in the next six months. Among the sub-segments, precision engineering is the most optimistic. This is followed by the electronics and bio-medical sectors.
• Manufacturing output is already in a steady uptrend, with the Purchasing Managers’ Index (PMI) for April seeing its 20th straight month of expansion, though the rate of growth has steadied over the last six months. This positive data points augurs well for industrial demand, where occupancy and rentals are showing signs of stabilisation, with supply effects slowing down. 
• Overall, we expect domestic industrial rents to increase by 1- 5% for 2018.
• Based on JTC Corp (JTC) data, about 1.6m sqm of industrial space is expected to come on-stream in 2018, with further supply tapering from 2019 onwards. By comparison, average supply stood at 1.8m sqm over last three years.
• Demand-supply dynamics remains the most favourable for the business park segment, followed by high-tech industrial spaces. While the logistics segment is still grappling from high-influx supply, we expect the segment to stabilise in 2H18 and see some pick-up by early 2019.
• For stock exposure, Ascendas REIT remains our Top Pick due to its well-diversified industrial property exposure and efficient capital recycling strategy. In the logistics space, we expect Cache Logistics Trust (Cache) to benefit from the logistics sector turnaround later this year.

Hospitality REITs – in a sweet spot.

• Singapore Hotel revenue per available room (RevPAR) has seen the first signs of rebound. Based on the Singapore Tourism Board’s (STB) official data, RevPAR increased 3% y-o-y for 2M18.
• It has to be noted that SGD Hotel RevPAR has been on a steady downtrend after peaking in 2012. Key reason for the decline was the higher hotel supply growth (4-5% pa), which exceeded demand growth (1-3% pa).
• With the supply effects tapering – CAGR supply of 1.3% pa between 2018-2020 – and demand drivers turning positive, we believe this sector is now ripe for a multi-year recovery.
• Overall, we expect RevPAR to increase by 3-7% in 2018, with the following factors being the key drivers:
  1. Visitor arrivals to increase by 4-7% in 2018;
  2. Improved GDP growth leading to higher corporate travel;
  3. A strong pipeline meetings, incentives, conventions, and events (MICE) activities, especially with Singapore holding the ASEAN Chairman post in 2018;
  4. Singapore to host the US-North Korea summit in June, which – in our view – ought to substantially boost the tourism profile of the nation.
• Our Picks for hospitality REITs are OUE Hospitality Trust, which is a pure-play in the Singapore hospitality sector. We also like CDL Hospitality Trust, which – despite its recent overseas expansion – remains one of the most liquid proxies to Singapore’s hospitality market.

Retail REITs – some positives, but the outlook remains soft.

• Despite the slight uptick in retail sales – excluding motor vehicles – in recent months, sentiment on the ground continues to remain weak. This is amid fast-changing consumer trends and the threat of e-commerce.
• Based on CBRE data, c.2.5m sq ft of retail supply, or 5% of inventory, is expected to come on-stream over next three years. This translates into around 0.83m sq ft pa of supply, which is higher than 10-year average net demand of about 0.68m sq ft. The higher supply, amid relatively weak retail demand, should continue to limit retail rent growth. We expect retail rent to stay flattish for 2018.
• Amidst the challenging environment, we expect only well-positioned defensive sub-urban malls to register decent performance. We recommend Frasers Centrepoint Trust (FCT) to investors looking for retail exposure. This is due to the upside from asset enhancements, a solid balance sheet and acquisition potential.

Office REITs – favourable dynamics, but minimal positive effect on REITs.

• Office supply for 2018 is expected to slow down to 1.8m sq ft in 2018 from 3m sq ft in 2017. Demand for office space has also seen an improvement in tandem with uptick in GDP growth. In 1Q18, Grade-A office rent rose 3% q-o-q based on preliminary CBRE data.
• While we expect Grade-A office rent to increase by 5-10% in 2018-2019, the positive flow- through effect on office REITs is likely to be muted. Based on our estimates the expiring rent for office leases – for the REITs under our coverage – is still about 5-15%. This is higher than the current market passing rent, as these were mostly signed during the previous peaks of 2013-2014. Thus we expect the positive impact (DPU growth) to be felt by 2020 only. 
• We remain Underweight on this sub-sector, and would recommend that investors wait for a pullback.

Overseas REITs – Manulife US REIT (MUST) a good proxy to the US economic growth.

• Among the overseas REITs listed in Singapore, we like Manulife US REIT for its pure-play office exposure to the rebounding US economy and office market.
• The impact of a rate hike also should be mitigated, as this would coincide with a pick-up in US office demand and potential strengthening of the USD, which would benefit unitholders.

Vijay Natarajan RHB Invest | https://www.rhbinvest.com.sg/ 2018-05-16

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