Singapore Retail Sector REITs Outlook - DBS Research 2019-01-03: A Rebound Against All Odds

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FRASERS CENTREPOINT TRUST (SGX:J69U) MAPLETREE COMMERCIAL TRUST (SGX:N2IU) CAPITALAND MALL TRUST (SGX:C38U)

Singapore Retail Sector REITs Outlook - A Rebound Against All Odds

• Anticipate higher rotational interest into the sub-sector as unique domestic factors promote resilience and growth amid global uncertainty.
• Concerns over potential oversupply overdone as high take-up rates for upcoming mega malls reflect healthy demand in the retail arena.
• REIT-owned malls better positioned to ride the recovery.
• Rental reversions a positive catalyst; upgrade to Positive from Neutral.

Bottoming out in 2019.

• With supply risk behind, we believe that the retail sector should improve visibility and operationally.
• Rental rates are starting to show signs of growth, after over a year of stabilisation. While disruption from e-commerce remains an overhang on the sector, we believe that propects are set to brighten ahead led by the resilient returns from its domestic-focus portfolios.
• For malls focused mainly on fashion, especially those along Orchard Road might continue to face challenges for the consumer wallet. That said, with new supply largely being pre-committed, we see moderating risks for the retail sector as a whole and expect rental reversions to bottom out in 2019. 

Demand and Supply Outlook

Supply

• Vacancy risks to contract further in 2019. After three years of limited supply from 2015-2017, the retail sector is experiencing a spike in completions in 2018 and 2019, mainly from three key projects: Northpoint City, Paya Lebar Quarter (“PLQ”) and Jewel Changi Airport (“Jewel”).
• Like previous years, new supply will largely originate from outside the central region, as the government’s ongoing push for decentralisation of live, work and play elements continues to take shape. Recent completions over 2018 include Century Square and Northpoint City, which are fully tenanted as of Nov’18. Over 80% and 90% of retail space at PLQ and Jewel have also been pre-committed ahead of their respective end-2018 and mid-2019 launches amid keen interest by retailers to tap opportunities in the suburban market. Funan is also set to return to the market in 2Q19 after a three-year hiatus and has secured > 70% of leases for its mall component to date.
• Going into 2019, we see the bottoming out of the retail sector and upside to rents as vacancy risks continue to contract given limited new supply and high pre-leasing activity.

Demand

• Healthy demand profiles should translate into higher rents. While retail occupancy rates across the island have moderated to 92.4% in 3Q18 from a peak of 95.5% in 2013, net absorption has turned positive over the past year, partly at the expense of rents. The rent index fell by 1.2% q-o-q and 2.7% y-o-y to 97.0, from 98.2 and 99.7, respectively.
• Notwithstanding the 0.5% supply boost, vacancy levels have eased y-o-y from 8.2% (3Q17) to 7.6% (3Q18) - which coupled with strong take-up rates for upcoming malls, reflects healthy demand in the retail arena. REIT-owned malls have generally fared better, both on the occupancy and rents front.
• For FY18, FRASERS CENTREPOINT TRUST (SGX:J69U) delivered industry-leading rental reversion of +3.2%, and successfully raised occupancy to 94.7% vs 92% a year ago, mainly on the completion of AEI at Northpoint. Occupancy for CAPITALAND MALL TRUST (SGX:C38U) also remained stable at 98.5%, with rental reversions ending in slight positive territory of +0.6% for 9M18.
• Looking into 2019, we are likely to see near-term disruptions to existing malls, particularly those in the Eastern region (Tampines Mall, 11.6% of CapitaLand Mall Trust top line) and Changi City Point (13.5% of Frasers Centrepoint Trust top line), and even as far as VivoCity (55% of MAPLETREE COMMERCIAL TRUST (SGX:N2IU) revenues) as the novelty factor by new offerings (especially with the opening of Jewel) will inevitably generate some diversion in shoppers’ travelling and shopping patterns. However, we do not expect these disruptions to be structural in nature as travel patterns should return to normalcy in the medium term as the effect runs out.
• Risks of tenant poaching meanwhile is also mitigated by the lock-in of leases at new spaces for an average of three years. Further, with several retail REITs starting to see positive reversions in the recent quarter, we believe the worst for the sector is almost over.

Key Trends

Impact of recent trends/developments in 9M18.

• After staying relatively range-bound over the last few years, retail sales have picked up modestly in recent years on the back of improving consumer sentiment, particularly in August and September, which saw RSI ex-motor vehicles pushing to 102.6 - 102.7 (implying growth of 2.2%-2.3% y-o-y), the highest observed level since Jan 2015. The positive momentum is a culmination of a multi-year effort by landlords to drive higher footfall and gain higher share of the consumer wallet.
• In the coming year, some recent trends/developments which we believe will remain prevalent include:
  1. Orchard to lead on the rent reversionary front.
     • Offering resilience from external headwinds and access to an immediate local catchment, the flight to the suburbs will remain a recurring theme going forward. While demand in OCR has typically tracked supply, has lagged slightly over the last six quarters - partly on strong supply growth (new retail floor space in the OCR region has grown by c.25% since 2011) and as rents ran ahead of tenant sales, in our opinion. Meanwhile, rents in the Central region have fallen by c.15% over the last three years, as landlords sought to strike a balance between rents and occupancy.
     • The results are more evident within the Orchard planning area, which registered a notable pick-up in occupancy from a low of 90.8% in 2Q16 to stabilise around the 94% level in recent quarters. Ahead, as expansion of retail space will largely stem from the suburbs, rent reversions in the Orchard area may outperform its fringe and suburban counterparts over the near-term given lack of new supply.
  2. Evolution of retail concepts.
     • Changing consumer lifestyles have sparked a reconstitution of tenant portfolios toward more activity-based offerings, including F&B, movie theatres, arcades and cooking schools. The first wave of tenant remixing has resulted in activity-based (i.e. food, education and entertainment) allocations rising to 30-35% currently, vs 20-25% on average across Singapore malls previously, which have anchored their resilience amid competition from e-commerce.
     • Going forward, O&O (“offline and online) concepts may be the new direction for retail, with experiential shopping taking centre stage as Landlords seek out collaborative partnerships with leading e-commerce disruptors to drive differentiation. Recent initiatives include CapitaLand Mall Trust’s
       1. NomadX, a multi-label concept store offering a blend of physical and digital elements and featuring the first physical outlet of Alibaba’s Taobao in Singapore and
       2. habitat by honestbee, a high-tech supermarket and dining concept.
     • Playing to the “Live, Work, Play” theme, co-working operators such as Justco and WeWork are also expanding their reach into retail hubs and anchoring retail spaces - a trend which will likely intensify going forward.
  3. And the cap rate compression trend continues...
     • the surge in retail space supply in 2018-2019, independent valuers have further tightened the cap rates used for the valuation of retail malls this year, with smaller, suburban malls leading the decline.
     • Cap rates for Frasers Centrepoint Trust’s smaller assets compressed by 25 bps in September, while its crown jewel Causeway Point tightened by 15 bps, in line with the market.
     • Similarly, CapitaLand Mall Trust saw cap rate compressions of 15bps across its suburban portfolio in June, vs 10 bps for its central/fringe malls. The c.14% increase in average valuations for Westgate, which was successfully acquired by CapitaLand Mall Trust from its Sponsor in November at an initial yield of 4.3%, implies that the improving trading environment has driven largely by the limited availablity of quality assets for purchase and thus a further compression in cap rates. Given allievating uncertainty in the local retail outlook and lack of investible assets amid an ample liquidity environment, we expect cap rates to remain tight in 2019.
  4. REITs-owned malls to shine brighter amid uneven recovery.
     • Over the last few years, retailers have been hit by several factors:
       1. declining sales efficiency on sales leakages from the proliferation of overseas travel,
       2. labour challenges arising from restrictions on foreign labour and minimum wage policies, and
       3. flattish consumption trends.
     • However, the impact was not felt evenly across all malls as REIT-owned malls continued to post tenant sales and rental income growth despite the tough retail cycle, outperforming individually owned spaces. Well-located portfolios with access to immediate catchment populations, predominant exposures to neccessity shopping and REIT managers’ holistic approach towards tenant remixxing have underscored their resilience thus far.
     • To sustain outperformance ahead, we believe that landlords’ ability to simultaneously deliver on both the novelty and comprehensiveness aspects and establish lasting differentiation amid rising competition from e-commerce will be key.

Derek TAN DBS Group Research | Mervin SONG CFA DBS Research | Carmen TAY DBS Research | https://www.dbsvickers.com/ 2019-01-03

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