Singapore REITs - DBS Research 2018-08-24: Flight To Safe Havens


Singapore REITs - Flight To Safe Havens

Flight to safety driving investor interest in REITs.

  • There has been good interest in S-REITs over the last couple of months. With the sector bouncing 4.6% from the lows in June as property funds switched from developers due to the additional property cooling measures in Singapore and generalist funds seeking yield given the uncertain macro backdrop arising from the trade war between China and the US. This was despite interest rate fears and the US Federal Reserve lifting the Fed Funds rate by another 25 basis points (bps) in June with yield spreads compressing to 3.2% from 3.7%.
  • With the expected improvement in fundamentals given easing supply pressures and investors refocusing on yield instruments, we believe S-REITs are poised to sustain their rally to bring yield spreads towards the c.3% level.

~ SGinvestors.io ~ Where SG investors share

Further growth in green shoots across all real estate subsectors.

  • The green shoots we saw in the prior quarter was sustained with grade A office rents rising 4% q-o-q to $10.10 per square foot per month (psf/mth) with office REITs fast approaching a period of positive rental revisions.
  • In Singapore’s hospitality sector, the uptrend in revenue per available (RevPAR) was also intact, jumping 4% y-o-y. However, hospitality REITs with a bigger exposure to upscale hotels disappointed due to softer corporate bookings during the Trump-Kim summit and difficulty in maximising yields due to late bookings by guests.
  • In the retail sector, the pace of negative rental revisions moderated, while industrial rents are bottoming with the odds of a recovery next year increasing.

Position in office and industrial REITs.

  • The office sector remains our preferred sector with CapitaLand Commercial Trust (Target Price S$2.12) as our top pick given sustained improvement in office rents. We now also advocate a larger weighing in the industrial sector ahead of hospitality REITs (previously our second favourite sector) as we are now 12 months away from a recovery in industrial rents while overseas hotel markets that the REITs are exposed to are facing near term softness.
  • Ascendas REIT (Target Price S$3.00) and Mapletree Logistics Trust (Target Price S$1.53) are our preferred industrial REIT picks while we remain bullish on CDL Hospitality Trusts (Target Price S$1.95) for its attractive valuation.
  • Our top retail pick is Frasers Centrepoint Trust (Target Price, $2.45) due to the strong near term DPU growth owing to the completion of asset enhancement initiatives (AEIs) at Northpoint City. Upside will come from potential acquisitions.

Marketing Feedback

Time for S-REITs to shine.

  • In our marketing sessions in the region, we noted that there was strong interest from investors to return to “safer havens” like S-REITs given the macro uncertainties while the recent government tightening in the property sector kept sentiment subdued in the developer space.
  • Among S-REITs, most investors acknowledge that the office sector appears the most interesting subsector given improving fundamentals which historically have been a key driver to share price. That said, expectations are already largely priced in, which makes it hard for office S-REITs to outperform expectations. That said, we prefer to be remain long in office REITs as we are still early in the upcycle.
  • Our preference for industrial REITs was well received by investors given that this subsector
    1. has quality large cap and quality names,
    2. offers yields above the S-REIT sector average with a yield spread of 6.2% (vs the sector’s 3.7%) which is an added buffer against the 10-year yield, and
    3. has upside earnings risk from acquisitions, when executed upon.
  • Retail S-REITs attracted interest and has performed well YTD as the stock market had corrected in 1H18. This was largely due to the perception that the retail sector is resilient against macro uncertainties. With investor expectations for retail REITs still fairly subdued, we believe that the retail S-REITs can hold onto most of their recent gains.
  • Hotel S-REITs continue to garnet interest but investors have turned a little cautious given the mixed operating numbers in 2Q18 while global uncertainties kept most investors away given the sector’s volatility. That said, most investors continue to remain vested given attractive valuations in hotel REITs.

Many positives from recent reporting season

  • During the recent reporting season, results for the June quarter were generally in line with expectations with the exception of hospitality REITs which disappointed largely due to exposure in the upscale hotel category which has lagged the overall recovery in the Singapore hospitality market as they were more impacted by corporate travellers who avoided Singapore during the Trump-Kim summit, and difficulty in maximising yields as hotel guests made late bookings.
  • Nevertheless, for the second consecutive quarter, the Singapore-focused hospitality REITs delivered y-o-y increases in DPU, after a challenging 3-4 years which was characterised by an oversupplied market. Going forward, with new supply muted, growing between 1-2% p.a., and demand still healthy as seen by 7.6% y-o-y in tourist arrivals in 1H18, we believe the disappointment is temporary and we expect to see a sustained multi-year recovery in hotel room rates and occupancy.
  • Meanwhile, office REITs reported flat to slight y-o-y declines in DPU. This was largely due to the impact of the negative rental reversions. However, with Grade A office rents reported to have increased by another 4% q-o-q or 13% y-o-y to S$10.10 psf/mth, up from the low of S$8.95 psf/mth in 1H17, and the continued recovery in office rents expected over the next few years due to limited supply until 2020/2021, we expect the flattish to negative rental reversions to turn positive soon, translating to a y-o-y increase in DPU.
  • The positive tone we are starting to see was also extended to the retail sector, as the downward pressure on DPU from negative rental reversions is easing. Index heavy weight CapitaLand Mall Trust (CMT) has now reported two consecutive quarters of positive rental reversions, following the declines during 2017. While supply pressures are expected to continue until the opening of Changi Jewel in 2019, we believe we are a close to the bottom in terms of pressure on rents, given that a majority of the new retail space is already committed and the Singapore economy remains buoyant; our DBS economists are projecting 3% GDP growth for this year.
  • As expected, the smaller industrial REITs struggled due to the declines in industrial rents and their smaller and concentrated portfolios. However, the larger industrial REITs continued to deliver steady DPU growth largely on the back of acquisitions made over the past year as well as higher income from properties located outside Singapore which has justified their decision to expand overseas over the past few years.

Office remains our preferred sector with a switch to industrial from hospitality as our second preferred sector

  • The office sector remains our preferred sector on the back of a sustained improvement in office rents, modest increase in new supply over the next three years, and that office REITs are fast approaching a period of positive rental reversions.
  • A change we have made in this report is the industrial sector is now being our second preferred pick (vs the hospitality sector previously) as we are now 12 months away from a recovery in industrial spot rents. Furthermore, with the large cap industrial REITs are trading at 6.1-6.2 yields, we believe they are in a strong position to pursue DPU accretive acquisitions. 
  • In addition, we have downgraded the hospitality sector to third ranking in terms of our sector preference as the overseas markets that the hospitality REITs are exposed to, namely Australia and Japan, are facing near term headwinds due to the high base effect and new supply.
  • Nevertheless, we remain bullish on the prospects of a recovery in the Singapore hospitality market on expectations of multi-year recovery in RevPAR.
  • Finally, while the retail REITs have rallied YTD as investors have sought more defensive investments given the more volatile and uncertain macro backdrop, we believe retail REITs are unlikely to break out of the their current trading range in the near term given investors’ concerns over structural headwinds from e-commerce.

Top picks

REIT Current Price (S$) 12mth Target Price (S$) Expected 12mth Total Return FY18/ 19F Yield FY18/ 19F P/Bk Rationale
Ascendas REIT (SGX:A17U)  2.73 3.00 16% 5.9% 1.30 Steady consistent performer with scale. Overhang from lack of CEO now removed.
CapitaLand Commercial Trust (SGX:C61U) 1.77 2.12 25% 4.9% 1.00 Leveraged to a multi-year recovery in the Singapore office market and trades at 1.0x P/Book, but during an upcycle CCT can trade up to 1.2x P/Book.
Mapletree Logistics Trust (SGX:M44U) 1.26 1.53 28% 6.3% 1.07 We believe that MLT’s brighter earnings prospects through organic improvement in its
core markets as well as recent acquisitions should translate to a higher share price going forward.
Suntec REIT (SGX:T82U) 1.89 2.30 27% 5.3% 0.90 Play on the turnaround of Suntec Mall and recovery in the Singapore office market, with upside from a potential takeover.
CDL Hospitality Trusts (SGX:J85) 1.55 1.95 32% 6.4% 1.01 Leveraged to the multi-year recovery in the Singapore hospitality market.
Frasers Centrepoint Trust (SGX:J69U) 2.28 2.45 13% 5.4% 1.12 Strong DPU growth on the back of the completion of AEI at NorthPoint.

Mervin SONG CFA DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2018-08-24
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