Singapore REITs - OCBC Investment 2018-12-03: Roll Out The Defensive Shield For 2019


Singapore REITs - Roll Out The Defensive Shield For 2019

3QCY18 DPU growth was flat, but an improvement from previous quarters

Positive DPU growth expected in 2019

  • Looking ahead, we are expecting positive DPU growth in 2019.
  • For our coverage universe, we are projecting stable DPU growth (market-cap weighted) of 0.3% for the current financial year (FY18/19F) and 2.4% for the next financial year (FY19/20F). This view is shared by the street, with Bloomberg consensus estimates pointing to DPU growth of 0.6%, 2.7% and 2.4% for FY18/19F, FY19/20F and FY20/21F, respectively.
  • As the majority of S-REITs have their financial year end in Dec (i.e. one quarter left to report for FY-1 (FY18/19F)), we believe it is more meaningful to look at the FY19/20F figures.

Sector preference: Retail > Industrial > Hospitality > Office

  • In terms of sub-sector preference, we rank retail REITs as our most preferred, followed by industrial REITs, hospitality REITs and office REITs.
  • While we are cognisant that near-term supply pressures would be highest for retail, we expect the retail REITs under our coverage to remain resilient. Furthermore, naysayers previously alluding to the doom and gloom of brick-and-mortar retail in Singapore have largely toned down their pessimism, in our view. Some of the retail REITs we cover such as Frasers Centrepoint Trust and Mapletree Commercial Trust have also established a strong track record of delivering positive growth in their DPU every financial year since their listing.

Prudent capital management to provide buffer against a higher interest rate environment

  • We note that the 3-month and 6-month swap offer rates (SOR) have increased from 1.10% and 1.24% at the start of the year to 1.84% and 1.94%, respectively, implying a higher borrowing cost environment.
  • Meanwhile, although the SGD interest rate swaps (IRS) have also risen since the start of the year, the 1-year, 2-year and 5-year IRS have eased slightly by 6, 20 and 33.4 bps, respectively, from the recent peak in Oct. This would provide a window of opportunity for REIT managers to increase their interest rate hedges. We believe the S-REITs under our coverage have continued to be prudent on their capital management.
  • The average gearing ratio stood at 35.1%, as at 30 Sep 2018, with 76.1% of their borrowings hedged/fixed. Meanwhile, the average debt to maturity was 3.3 years, with an average debt cost of 2.8% and interest coverage ratio of 5.2x. Based on our sensitivity analysis, for every 100 bps increase in borrowing costs, the average impact to our DPU forecasts would be -2.3%.

A deep dive into the performance of the S-REITs sector during the last and current major rate hike cycle

  • During the last major rate hike cycle, the Federal Reserve raised the fed funds rate several times from 1.25% in Jun 2004 to 5.25% in Jun 2006 before cutting rates by 50 bps to 4.75% in Sep 2007. During the period from Jun 2004 to Sep 2007, the FTSE ST REIT Index (FSTREI) appreciated 85.6%, or 21.2% on an annualised basis.
  • The next leg saw the Fed funds rate being lowered from 4.75% in Sep 2007 and kept near zero until it was increased again in Dec 2015 by 25 bps to 0.375%. During this period, the FSTREI fell 27.7%, or -3.9% on an annualised basis.
  • The current ongoing cycle has seen the Federal Reserve hiking rates by eight times from Dec 2015 to Sep 2018 (inclusive). The current dots plot diagram suggests one more hike in Dec, and three in 2019. From Dec 2015 to now, the FSTREI rose 14.1% (up to 29 Nov 2018), or 4.6% on an annualised basis.
  • Although the FSTREI is down 8.8% YTD, on a total returns basis it is less negative at -3.3% and this was an outperformance as compared to STI’s -5.2% total returns. While concerns over the possibility of 3-4 rate hikes in 2019 are valid, we highlight two key points to assuage these concerns.
    • First, we have observed that S-REITs can still perform well during a rate hike cycle, as illustrated above.
    • Secondly, the pace of rate increases will be data dependent, and this was reinforced by Federal Reserve Vice Chairman Richard Clarida in his speech in New York last week. This suggests that should the economy enter a speed bump, the trajectory of the interest rates would likely be adjusted as well.
  • Federal Reserve Chairman Jerome Powell also said that interest rates are “just below” a range of estimates of the so-called neutral level, and this is seen by the market as being relatively dovish in nature.

Valuations more reasonable; NEUTRAL but with bias to the upside 

  • Valuations for the S-REITs have become more reasonable, although not yet at attractive levels, in our opinion. The forward yield spread between the FTSE ST REIT Index (6.3%) and the Singapore government 10-year bond yield (2.36%) last stood at 394 bps. This is approximately three-tenths of a standard deviation below the 5-year mean of 407 bps.
  • However, with increasing concerns and uncertainties over global economic expansion next year, we opine that quality defensive yield plays can provide investors an avenue to weather the uncertainties ahead. Furthermore, we believe recent commentary by Fed officials has helped to assuage some worries about the pace of rate hikes ahead.
  • Heading into 2019, we maintain NEUTRAL on S-REITs, but with a bias to the upside.
  • Our preferred picks are 

RETAIL SECTOR: Commendable efforts on repositioning to drive resiliency

Contrasting retail rental data from URA and property consultants 

  • Based on URA statistics, Singapore’s q-o-q retail rental growth remained in negative territory in 3Q18, similar to 2Q18, after registering positive growth in 1Q18. The decline in 3Q18 rentals was broad-based, coming in at -1.2% and -0.9% for the Central Area and Fringe Area, respectively. This culminated in an overall 1.2% dip for the Central Region.
  • Notwithstanding this gloomy set of data, we note that retail rents published by property consultants painted a contrasting picture. According to CBRE, retail rents for the Orchard Road sub-market grew 0.8% q-o-q to S$31.70 psf/month; rents for the Other City/City Fringe and Suburban sub-markets rose 0.3% and 0.2% q-o-q to S$17.15 psf/month and S$29.15 psf/month, respectively; while retail rents for the City Hall/Marina Centre sub-market was unchanged sequentially.
  • Separately, Colliers’ data pointed to a 0.8% q-o-q growth in gross retail rents to S$40.70 psf/month for 3Q18. It also highlighted in its semi-annual retail report that it expects ground-floor rents, particularly in the Orchard Road area, to steer the gradual rental recovery from 2018 to 2022. We believe the data points from the property consultants would be more relevant for the retail REITs.

Singapore retail sales excluding motor vehicles have largely stayed in positive territory this year

  • Singapore’s retail sales excluding motor vehicles have been largely resilient this year, with positive y-o-y growth registered from Feb to Sep (Jan -7.3% y-o-y due to Chinese New Year effect). The latest data available for the month of Sep pointed to positive growth of 1.8% y-o-y to S$3.6b, as there were encouraging growth from Watches & Jewellery (+7.4%), Wearing Apparel & Footwear (+3.0%) and Food Retailers (+2.5%). This was partially offset by Computer & Telecommunications Equipment (-5.8%), which we opine is more susceptible to the threat from e-commerce.
  • Nevertheless, we note that online retail sales accounted for an estimated 4.9% of total retail sales, based on data from the Department of Statistics Singapore.

Keeping a watchful eye on supply in 2019

  • Amongst the major sub-sectors, retail appears to have the highest supply pressure in 2019. Based on data from CBRE, approximately 1.54m sq ft of retail space is estimated to come on-stream next year, versus 724.9k sq ft expected for 2018. Supply pressures will then taper off significantly in 2020 and 2021, with only 115.3k sq ft and 91.5k sq ft of new supply, respectively.
  • For 2019, key completions include Jewel Changi Airport (~576k sq ft), Paya Lebar Quarter (~340k sq ft), and Funan redevelopment (~325k sq ft). This will likely have an impact on the malls located in the East, given the novelty effect and advertising and promotional events which is typical of a new mall opening.
  • Nevertheless, the firm pre-commitment levels at Jewel (~90%) and Funan (~70% for retail component) prior to their completion sends a positive signal that retailers, including new-to-market brands, are still keen to gain exposure to the local retail scene. Retailers and landlords are also continuing to embrace omni-channel strategies to provide consumers with an experiential shopping experience.

Retail REITs continue to exhibit resilient operating metrics 

  • Looking across the performance of the retail REITs with significant local exposure, we note that CapitaLand Mall Trust, Frasers Centrepoint Trust (FCT) and Mapletree Commercial Trust continued to deliver positive rental reversions for 3QCY18, albeit at low single-digit levels. For Frasers Centrepoint Trust, rental reversions moderated to +0.2% from +5.0%, but still came in +3.2% for the full financial year. Occupancy rates remain largely firm at 95% and above for the Singapore properties of retail REITs. Tenants’ sales and footfall were mixed, but still largely resilient, in our view.
  • Overall, we forecast prime Orchard Road rental growth to come in between 2%-3% in 2019, while suburban rents are expected to increase steadily by 1%-2%.
  • Among the retail REITs, our top picks are Frasers Centrepoint Trust [Rating: BUY; Fair Value: S$2.50] and Mapletree North Asia Commercial Trust (MNACT) [Rating: BUY; Fair Value: S$1.34]. For Mapletree North Asia Commercial Trust, management highlighted that it has not seen any impact from the ongoing Sino-U.S. trade tensions, while operating metrics continue to be robust. It will continue to hedge its FX on a rolling four-quarter basis.

OFFICE SECTOR: Strong 2018, but rental growth to moderate in 2019

Office rents enjoying a robust growth trajectory in 2018

  • Leasing momentum for the office sector remained robust, with Grade A core CBD office rents growing 3.5% q-o-q to S$10.45 psf/month in 3Q18, according to CBRE’s data. This was the fifth consecutive quarter of growth. This trend was also mirrored by the Grade B core CBD sub-market, which saw a 2.6% q-o-q increase in rents to S$8.00 psf/month.
  • Cumulatively, Grade A and Grade B Core CBD office rentals are currently up 11.2% and 7.4% for 9M18, respectively, as compared to end-2017 levels. Demand has been underpinned by co-working operators, Telecommunications, Media and Technology (TMT), business consultancy and financial services sectors. Both Grade A and Grade B occupancy rates inched up by 0.5 ppt q-o-q to 94.6% and 94.7%, respectively. There was positive net absorption of 66.6k sq ft and 493.6k sq ft for the former and latter in 3Q18, respectively.
  • We expect core Grade A office rentals to end 2018 with an increase of 13%-15%. Thereafter, in light of a higher base and expected slowdown in global economic conditions, we forecast rental growth to moderate to 5%-8% in 2019.

Supply will remain manageable from 2019-2021F

  • On the supply front, ~912k sq ft of net new supply was added islandwide in 9M18. Including an estimated 5.3m sq ft of new supply islandwide expected from 4Q18 to 2022, we estimate that there will be an average supply of ~1.25m sq ft per annum from 2018 to 2022, which is below the 5-year average net new office supply of 1.34m from 2013 to 2017. If we focus only on the Central Area, the forecasted average annual gross new supply would be 0.8m sq ft, versus the average annual net supply of 1.0m sq ft from 2013 to 2017.

Tight cap rate transactions for office assets

  • Recent transactions of office assets in Singapore have also painted a rosy picture, as a number of these deals were transacted at tight cap rates.
  • For example, in 3Q this year, CapitaLand Commercial Trust divested Twenty Anson for S$516.0m, or S$2,503 psf NLA (19.2% above valuation as at 31 Dec 2017). This translates into an exit NPI yield of 2.7%. Another recent deal was the divestment of 55 Market Street by Frasers Commercial Trust for S$216.8m (S$3,020 psf), or an implied exit NPI yield of 1.6%. The Twenty Anson transaction augurs well for Mapletree Commercial Trust’s Mapletree Anson, in our view, as the two properties are located adjacent to each other. Mapletree Anson was valued at a cap rate of 3.7%, as at 31 Mar 2018.
  • Our preferred office REIT is Frasers Commercial Trust (FCOT) [Rating: BUY; Fair Value: S$1.56]. We believe the final tranche of HP’s planned expiries at Alexandra Technopark (ATP) by end-Dec 2018 has already been factored in its share price. With ATP’s AEI nearing completion, we see a gradual ramp-up in the backfilling of its vacated space. The recent divestment of 55 Market Street has also provided it with ample debt headroom to grow its portfolio accretively.

INDUSTRIAL SECTOR: Prefer industrial REITs with significant overseas exposure

Industrial rents have declined 0.1% q-o-q for four consecutive quarters

  • Based on JTC data, the rental index for all industrial space declined marginally by 0.1% q-o-q in 3Q18. This was the fourth consecutive quarter whereby rents fell 0.1% sequentially. Only the Multiple User Warehouse segment saw flat rental growth, while all other segments had slight q-o-q dips, including Business parks (-0.1%), which had previously registered five straight quarters of positive growth.
  • Leading indicators such as the Singapore Purchasing Managers’ Index (PMI) remained in expansionary mode, but have been easing. Both the Manufacturing and Electronics PMI saw consecutive declines for both Sep and Oct.

Overall supply expected to be higher in 2019 than 2018

  • In terms of supply, after 447k sqm of industrial space had come on-stream in 9M18, an estimated 1.8m sqm of industrial space is expected to enter the market in 4Q18 and 2019, representing ~4% of current industrial stock, according to JTC. To put things in perspective, over the past three years, the average annual demand and supply were 1.2m sqm and 1.6m sqm, respectively.
  • For the multiple-user factory space, ~302k sqm of supply is expected to come into the market in 4Q18 and 2019, versus an annual demand and supply of 254k and 369k sqm over the past three years, respectively.

Business parks continue to exhibit favourable demand and supply dynamics

  • Business parks are part of the Singapore government’s decentralisation focus to encourage eligible businesses that do not necessarily require a CBD location to consider having their operations in the suburbs instead.
  • According to CBRE, Mapletree Business City (MBC) is one of the newest business parks in Singapore, and comes with Grade A specifications, integrated business hub features and the added advantage of being located reasonably close to the CBD core. The typical tenant profile of tenants at MBC is different from those of traditional business parks and is more similar to the tenant profile in the CBD Core. Business park rents have been largely stable, with 3Q18 city fringe rents increasing 1.8% q-o-q to S$5.80 psf/month (five consecutive quarters of q-o-q growth), while rest of the island business park rents improved 1.3% q-o-q to S$3.80 psf/month (two straight months of q-o-q growth).
  • In terms of upcoming supply, we note that according to JTC data, there is 317k sq m of business park supply from 4Q18 onwards, representing 14.8% of the current stock. However, only 77 sq m and 17 sq m are expected to come on-stream in 4Q18 and 2019, respectively.

GIC’s increased presence to Australia’s logistics market a positive signal

  • GIC, Singapore’s sovereign wealth fund, announced on 26 Nov this year that it has formed a joint venture with Dexus, an Australian REIT, to establish a new ~A$2b unlisted trust named Dexus Australian Logistics Trust (DALT). DALT will invest in logistics properties in Australia, and will be initially seeded with a A$1.4b high quality logistics portfolio which are located predominantly in Sydney and Melbourne.
  • According to GIC’s CIO of Real Estate, this JV is a reflection of GIC’s confidence in the long-term potential of Australia’s logistics sector, underpinned by structural and consumption growth arising from favourable demographics and e-commerce growth.

Frasers Logistics & Industrial Trust and Mapletree Logistics Trust our preferred industrial REITs

HOSPITALITY SECTOR: It’s time for RevPAR growth

Singapore tourism statistics have been resilient

  • Total international visitor arrivals to Singapore remained buoyant, growing at a healthy clip of 7.5% y-o-y to 14.0m for the first nine months of 2018. Meanwhile, industry-wide RevPARs improved 3.3% to S$190.0 for the same period, underpinned by higher occupancy (+1.7% to 86.9%) and average room rate (+1.6% to S$218.7).
  • As for tourism receipts (TR), it came in flat y-o-y at S$13.4b for 1H18. This can be attributed to lower expenditure across some components including Shopping (-15%), Food & Beverage (-13%) and Accommodation (-1%), but offset by Sightseeing, Entertainment & Gaming (+2%) and Other TR Components (+22%). The top three countries which delivered highest absolute y-o-y growth in TR were India (+19%), China (+13%) and Indonesia (+9%).

Mixed operational performance from hospitality REITs

  • The operational performance for the hospitality REITs were mixed in 3Q18. On the Serviced Residences segment, the main positive surprise came from Ascott Residence Trust, which posted a strong 16% y-o-y growth in its Singapore portfolio RevPAU (overall portfolio +8% y-o-y). This was underpinned by higher market demand from both corporate and leisure.
  • On the other hand, Far East Hospitality Trust (FEHT) saw a 5.4% y-o-y dip in its 3Q18 RevPAU, largely due to muted corporate employee relocation activity. On the Hotels front, 3Q18 RevPAR for CDL Hospitality Trusts Singapore portfolio fell marginally by 0.3% (partly impacted by its Orchard Hotel AEI); Far East Hospitality Trust’s RevPAR jumped 6.6% y-o-y due to the inclusion of Oasia Hotel Downtown; OUE Hospitality Trust’s Mandarin Orchard Singapore RevPAR slipped 3.7% y-o-y but that of Crowne Plaza Changi Airport grew 6.3%.

However, signs of robust RevPar pickup could be on the horizon 

  • Looking at the hospitality sector as a whole, we expect strong RevPAR pickup in 4Q18 and 2019. A noteworthy detail was the disclosure by CDL Hospitality Trusts that its Singapore hotels portfolio registered a stellar 7.2% RevPAR growth for the first 29 days of Oct.
  • Looking at upcoming supply, after a 4.8% and 5.1% net inventory growth in 2016 and 2017, respectively, an estimated 47 net rooms would be added in 2018 (+0.1%), followed by 1,914 net rooms in 2019 (+2.9%) and 651 net rooms in 2020 (+0.9%), according to market watcher Horwath HTL.
  • Our preferred pick in the hospitality REIT space is OUE Hospitality Trust [Rating: BUY; Fair Value: S$0.79]. We like OUE Hospitality Trust for its attractive valuations and see it as a beneficiary when Jewel Changi Airport opens in 1H19.
  • Please refer to our SG Hospitality Sector report titled “Get ready to surf the wave!” which was published on 30 Nov 2018 for more details.

Andy Wong Teck Ching CFA OCBC Investment Research | Deborah Ong OCBC Investment | Joseph Ng OCBC Investment | https://www.iocbc.com/ 2018-12-03
SGX Stock Analyst Report BUY MAINTAIN BUY 1.340 SAME 1.340