S-REITs - CGS-CIMB Research 2018-07-05: Yield Spread Still Under Pressure

S-REITs - CGS-CIMB Research 2018-07-05: Yield Spread Still Under Pressure Singapore REITs SREIT Yield Spread CAPITALAND COMMERCIAL TRUST SGX:C61U CDL HOSPITALITY TRUSTS SGX:J85

S-REITs - Yield Spread Still Under Pressure

  • The office sub-sector continues to show the most supportive supply/demand dynamics for a rental recovery, with broadening appetite from the services sector and medium-term supply squeeze of new Grade A space in the CBD. Rising spot rents should result in positive rental reversion from next year.
  • The hospitality sector is also expected to benefit from a continued upturn in REVPAR with limited new supply over the next 2-3 years.

After declining c.6.8% YTD, S-REIT valuations have reverted close to 5-year mean.

  • The S-REIT sector is trading at 5.6% 2018F dividend yield, which is just under the long-term (5-year) average yield level while at 1x P/BV, valuations are just under the long-term average of 1.03x. However, on a yield spread basis, the 310bp spread over the 10-year bond yield is just shy of the long-term average of 332bp.
  • While S-REITs have mean-reverted at present and continue to deliver DPU growth, we believe the rising rate outlook would continue to put yield spread under pressure.
  • In terms of capital management, SREITs' gearing has risen to 36.1% from 34.6% a quarter ago due to funding for new acquisitions. Nonetheless, overall balance sheet remains robust with c.78% of sector debt on fixed rate terms. There is also little refinancing risk with c.9% and 15% of sector debt to be refinanced in the remainder of 2018F and 2019F, respectively.
  • The three-month SIBOR, and two-and-10-year rates have increased 50-70bp from a year ago. CIMB Treasury and Fixed Income Research team maintains its stance of expecting four US Fed fund rate hikes this year. Hence, we expect funding rates to remain on the rise in the near term. However, SREITs have locked in the bulk of their financing costs, thus mitigating the erosive impact of higher interest cost on earnings. For every 0.5%-pt increase in average funding cost, distribution income could be reduced 0.3-4%, in our estimate.
  • SREITs results in 1QCY18 were largely in line with expectations. Post completion of asset acquisitions YTD, we estimate the SREIT sector to deliver 1.9% and 2.7% DPU growth over FY18F and FY19F.

Office sector still our preferred top sub-sector

  • The office market continued to remain buoyant with the 1Q18 URA Central Region office price and rental index up 4.4% and 7.7%, respectively, from the low of mid last year. We anticipate this trend to continue into 2Q as well. Grade A rents continue to power ahead of the anticipated near term supply squeeze compared to the Grade B and quasi-office (business parks) properties.
  • This market is likely to remain favourable to landlords, particularly in the CBD, in view of the limited upcoming supply. We estimate completions in 2018F to total 1.65m sq ft, and include Frasers Tower (85% pre-leased) and Paya Lebar Quarters (PLQ) (50% pre-leased). Some of the major leasing transactions announced include SMRT’s 100,000 sq ft lease at PLQ, legal firm Rajah & Tan taking up 85,000 sq ft at Marina One, and Chevron Petroleum relocating with a 73,000 sq ft lease at DUO.
  • As such, we project that the overall Singapore office occupancy, which stood at 87.5% at end-1Q18, to improve to close to 89% over the next 2-3 years. We estimate net office absorption to be around 1.2m-1.5m sq ft annually over the next 1-3 years.
  • According to Ministry of Trade and Industry, Singapore’s GDP is forecast to grow at 2.5-3.5%. The increased economic activity which has broadened to the services sector as well should bode well for office space consumption. io. Key risk is a prolonged uncertainty over the trade tension between US/China/Europe which could dampen growth.
  • The office transactions market continue to be upbeat. The latest office deal in 2Q18 is CapitaLand Commercial Trust (CCT)’s divestment of Twenty Anson to a third party for S$516m (S$2,503psf) which equates to a 2.7% net property yield. We think this will continue to underpin capital values in the near term. In addition, with narrow yield spread for domestic assets, we believe property investors could continue to look overseas for acquisition targets.
  • Under this operating environment, we continue to prefer landlords with more prime Grade A office exposure such as CapitaLand Commercial Trust (CCT) and Keppel REIT (KREIT).

Hospitality sector’s rising tide lifts all boats

  • Visitor arrivals continue to be healthy, growing 6.7% y-o-y in 4M18 to 6.18m. By volume, China and Indonesia were the top two source of visitors to Singapore, up 10.9% and 1.5% y-o-y respectively, over the same period.
  • Going into 2H, we expect the visitor arrival momentum to be sustained given that there will be more biennial events being held in even years. Hence, we forecast 4% y-o-y growth in tourist arrivals to c.18.1m for 2018F.
  • Meanwhile, we expect incoming supply of hotel rooms to taper off from 2018F, after the past five years' CAGR of 5.1%. io. Horwarth HTL estimates that an additional 2.5% of total room stock would come on-stream in 2018F, followed by a much lesser 0.8% and 0.6% of new inventory scheduled for completion in 2019/20F. Looking at the breakdown in new supply, we note the bulk (52%) of new incoming hotel rooms are in the mid-tier category.
  • Putting together demand and supply, we are forecasting REVPAR growth of c.4% for 2018F. With the anticipated lower incoming supply, we think hotel occupancy should continue to trend up from the 84.6% at end-2017 to the high 80s% by 2020F. With the hotel recovery in sight and better operating metrics, we anticipate hospitality REITs to do well this year.
  • Hospitality S-REITs enjoyed positive y-o-y REVPAR growth in 1QCY18 and the trend for Apr 2018 remained generally upbeat. Given the see-through from tourist arrivals and industry data released so far, we anticipate the positive trend to continue into 2Q. With this recovery in sight, hospitality REITs such as CDL Hospitality Trusts (CDREIT) and OUE Hospitality Trust (OUEHT) have outperformed the broader S-REIT market YTD. See Share Price Performance - S-REITs Sector.
  • As investors remain cautious, we believe the larger cap hospitality REITs such as CDL Hospitality Trusts (CDREIT) should continue to hold up well. CDREIT remains our preferred pick in the sector.

Stock Picks

CapitaLand Commercial Trust (CCT, Target Price: S$1.90)

  • CapitaLand Commercial Trust (CCT) offers investor exposure an almost pure exposure to the Singapore office rental market recovery. The trust is also able to rejuvenate its portfolio through AEIs and redevelopment activities. Recent divestment of Twenty Anson at an attractive yield of 2.7% would enable the group to build more balance sheet capacity for new acquisitions.
  • CCT is trading at 5.3% FY18/19F DPU yield which has factored in impact from the recent divestment.

CDL Hospitality Trust (CDREIT, Target Price: S$1.92)

  • CDL Hospitality Trusts (CDREIT) is the bellwether hospitality stock and is expected to continue to outperform during the cyclical upturn. It has enjoyed a 0.8% y-o-y improvement in 1Q18 and we have imputed a 5% REVPAR growth for 2018F and another 7% improvement in 2019F. Given the current low gearing of 33.2%, we believe there is also room for acquisition growth.
  • CDREIT is trading at 6.3-7% FY18-19F DPU yield

LOCK Mun Yee CGS-CIMB Research | https://research.itradecimb.com/ 2018-07-05
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