Navigating Singapore 2019 ~ SREITs - CGS-CIMB Research 2018-11-29: OVERWEIGHT


Navigating Singapore 2019 ~ SREITs - OVERWEIGHT

Positive Trends

Office spot rents continued to rise in 3QCY18.

  • The rise in office spot rents have not been felt in a similar corresponding quantum in the recent 3QCY18 reported results for office SREITs as renewal cycles tend to lag spot rate movements. That said, rental reversions have been flat or the negative reversion gap has narrowed significantly over the past two quarters.
  • Portfolio occupancy of major landlords such as Keppel REIT (SGX:K71U) saw some volatility owing to lease pre-termination, although these have been largely back-filled. For CapitaLand Commercial Trust (SGX:C61U), rental reversions stayed flat or slightly negative as the high-base rents continue to roll off on renewals.

Chinese tourist arrivals still growing.

  • Tourist arrivals continued to be strong at +7.5% in year-to-Sep 2018. Greater China tourists, making up 24.6% of total tourists into Singapore, grew at 9% y-o-y.

High occupancy above 97% for retail industry and improved on a qoq basis.

  • Rental reversions were also encouraging, with the majority of the malls delivering positive rental reversions in 9MCY18.

Negative Trends

Hospitality SREITs had slower-than-expected RevPAR growth, mainly due to one-off events.

  • CDL Hospitality Trusts (SGX:J85) reported negative Singapore RevPAR of - 0.3% due to the renovation of Orchard Hotel which commenced in Jul 2018. Excluding Orchard Hotel, Singapore RevPAR would have increased by 1.3%.
  • OUE Hospitality Trust (SGX:SK7) also reported a weaker -3.7% RevPAR in 3Q affected by the sudden booking cancellations from Japanese tour groups as a result of the airport closure in Osaka due to typhoon, as well as a higher base due to the large US navy group staying in the hotel in 3QFY17.

E-commerce threat.

  • Shopper traffic and tenant sales for retail SREITs remained relatively weak. The changing consumer demand and rising online shopping trend pose a long-term risk to the industry.

Q-o-q weakening Singapore portfolio among the industrial SREITs.

  • While industrial SREITs generally reported a set of in-line 3QCY18 results amid acquisition-driven growth and single-digit positive rental reversions, we note diverging operating metrics with Ascendas REIT (SGX:A17U) and Mapletree Industrial Trust (SGX:ME8U) reporting q-o-q weakening Singapore portfolio occupancy.
  • The smaller-cap SREITs continue to be adversely affected by multi-tenanted building (MTB) conversions with YTD single-digit negative rental reversions. Nevertheless, we anticipate industrial SREITs to remain active in investments as an avenue to grow income.

Looking to 2019: Office REITs

Office outlook remains bright.

  • According to Urban Redevelopment Authority (URA) 3Q18 statistics, office rents have climbed 12.2% from the low in 2017 and are up 6.9% since the beginning of this year. This is underpinned by higher island-wide occupancy of 88% and actual net absorption of 1.43m sqft for 9M18. With new supply in the CBD tapering off and some buildings taken out of circulation such as Chevron House (closed for major AEI from end-4Q18), we anticipate the supply squeeze to continue to drive rents.
  • There is no meaningful new incoming supply in the CBD (i.e. < 1m sqft) in 2019 and 2020. Hence, we anticipate the upward momentum in rents to remain intact in 2019, with a projected 5-10% rise in spot rents. The higher base in rents will gradually filter through to FY19 earnings of office SREITs.
  • Downside risk to this view is if macro events, such as the US-China trade tension, dampen the appetite for office space.

Looking to 2019: Hospitality REITs

Expect RevPAR recovery to accelerate in 2019.

  • Supply of new rooms in 2018 to 2020 is expected to taper down from 3,200 rooms in 2017 to just ~870 rooms/annum on average (1.3% CAGR in 2017-2000 versus 5.5% in 2014-2017). This should help to ease pricing pressure and boost RevPAR recovery momentum in 2019. Industry RevPAR grew 3.3% year-to-Sep.
  • We are hopeful that industry RevPAR will accelerate in the remainder of the year to achieve our 2018 RevPAR projection of 5%. In 2019, we are expecting a 2.5% y-o-y growth in RevPAR, incorporating a conservative 3% growth in tourist arrivals and room supply of 1,700 rooms.
  • Despite the stronger S$, we think our demand assumption should be achievable driven by the year-long calendar of events to commemorate the 200th anniversary of the founding of modern Singapore in 2019. The substantially lower supply should overrule the effects of Airbnb, which arrived in Singapore years ago.

Overseas ventures to continue.

  • Given the limited acquisition opportunities in Singapore due to the low cap rate of 2.5-3%, we believe the trusts will continue to look for acquisitions overseas, in particular in the Europe region due to low funding cost. CDL Hospitality Trusts has just acquired a hotel in Florence, Italy at a 4.6% acquisition yield and an assumed low funding cost of 0.7%.

Weak corporate demand will continue to weigh on serviced residence.

  • According to State Street Global Exchange, global investor confidence fell to 94.3 in August, the lowest reading since Feb 2017 when the index was 91.2. We believe the weak corporate demand may continue to weigh on the serviced residence but should have less impact on hoteliers due to the longer minimum stay period of 7 days for serviced residence.

Looking to 2019: Retail REITs

Lower supply in the next 3 years.

  • The retail space supply will taper off from the high of 1.5m sf in 2018 to 780k sf in 2019 and 467k sf in 2020. Of the total incoming supply, ~70% will be located outside central region and fringe area while only 5% will be located in Orchard region.
  • The lower supply should lend support to retail rents. More apparent recovery should be felt in 2020 after Jewel Changi, Paya Lebar Quarter and Funan establish themselves.

Weak spending limits the rate of recovery, malls need continue to innovate.

  • While we expect the lower supply to support retail rents, recovery would nonetheless be a gradual one in view of the weak shopper traffic and spending, especially when online shopping is taking up a larger pie of the retail sales.
  • We see retail malls accelerating the transformation from traditional mall to an “experimental” or “work-play-life” mall as shoppers shift their spending from shopping to experience. CapitaLand Mall Trust (SGX:C38U) is the leader in this as they transformed its digital mall Funan to an “online-offline” mall. It also converted 11k sf of retail space at Plaza Singapura to “physical + digital” concept store.
  • In the absence of major AEIs in 2019, we think that rental growth for the SREITs under our coverage would slow down from the high rental base registered in the past few years.

SREITs with sizeable malls and niche locations could brace against the effects of changes relatively better.

  • We believe malls in the suburban areas and sizeable operation scale would perform better than those without. Large scale malls have the leeway to make changes to adapt to the changing consumer demand. Therefore, mega malls such as Vivocity (owned by Mapletree Commercial Trust (SGX:N2IU)), Suntec City (owned by Suntec REIT (SGX:T82U)) and Westgate (owned by CapitaLand Mall Trust) should be able to brace the changing environment better than the smaller ones.
  • In addition, mega malls have also become destination malls due to the wide offerings in terms of tenant mix and activities offered. Suburban malls such as Causeway Point, Clementi Mall and Northpoint City are not as large as the destination malls but they have large population catchment around their vicinity and they offer convenience to the population nearby.

Looking to 2019: Industrial REITs

Supply to taper down slightly.

  • 1.28m sqm of supply, representing 2.6% of current industrial stock, is expected to come to market in 2019. This compares favourably with average annual supply of around 1.6m sqm in the past 3 years. However, this supply is not evenly spread out across sub-segments.
  • The declining occupancy for multi-user factories since 1QCY12 will persist as a bumper crop of supply representing 6% of existing stock will come onstream in 2020; 13% of existing supply is expected from 4QCY18 onwards.

Demand to remain soft; overseas acquisitions to supplement growth.

  • We expect demand to remain subdued due to uncertainties over the external environment (e.g. trade tensions) weighing on expansionary investment decisions for tenants.
  • In a softer local market situation, SREITs with an international mandate are expected to continue overseas expansion to drive growth. However, the pass-through effects of acquisitions on DPU growth could be muted as the increased cost of debt funding could also push SREITs to turn to equity fund raising as an alternative.

SREITs with diversified operations in a better position.

  • Light industrial properties are at a crossroads due to the trade tensions as those supporting domestic consumption would be relatively shielded from downside while those supporting cross-border trade may see some relocation of tenants. Therefore, SREITs with geographically-diversified holdings should be better able to cope with shifting supply chains assuming they have sufficient bandwidth to accommodate tenants in new geographies.

Well-located, high-spec properties and data centres will be the least affected.

  • Amid all the uncertainties, demand for well-located and higher spec properties should remain resilient as tenants become more selective. Demand for data centre space is also relatively insulated from trade war concerns and will continue to see growth as companies undergo digital transformation.

Stock preference

  • We maintain our OVERWEIGHT stance on SREITs as we expect investors to remain in risk-off mode given the uncertain macro outlook amid the ongoing trade tensions. DPU growth continues to be positive while SREITs are currently trading at 0.98x P/BV and 5.5% forward yield, representing 302 bp spread over the Singapore 10-year bond yield.
  • With the increasingly uncertain macro outlook, we move up our ranking of retail SREITs at the expense of industrial SREITs. Hence, our sub-sector preferences are office, hospitality, retail and industrial. Nevertheless, as sector yields remain firmly below average, investors continue to hunt for attractively valued large-caps with visible DPU growth.
  • Our top picks include CapitaLand Mall Trust (SGX:C38U) (Target Price: S$2.29) and CDL Hospitality Trusts (SGX:J85) (Target Price: S$1.63).
  • We like CapitaLand Mall Trust for its visible growth coming from the completion of Funan Lifestyle Mall as well as the recent purchase of the remaining 70% stake in Westgate. Supply of new malls is also tapering off post the opening of Jewel at Changi Airport in 1Q19. The share price surged in the past week and the stock offers c.10% total return to our target price.
  • We like CDL Hospitality Trusts for its visible low-base growth, which is expected to pick up momentum from 2H19 onwards. This is coming from the opening of the re-branded Raffles Hotel Maldives as well as the completion of asset enhancements at Orchard Hotel in Singapore. Recent acquisition of the Hotel Cerretani Florence, M Gallery by Sofitel in Italy should also boost contributions from FY19 onwards. New acquisitions could provide an upside surprise. The stock offers FY19 DPU yield of 6.5%.
  • We also like CapitaLand Commercial Trust as our proxy play for office market recovery.

LOCK Mun Yee CGS-CIMB Research | EING Kar Mei CFA CGS-CIMB Research | https://research.itradecimb.com/ 2018-11-29
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