Singapore REITs - OCBC Investment 2019-07-01: Healthy Fundamentals But It’s Getting Overcrowded


Singapore REITs - Healthy Fundamentals But It’s Getting Overcrowded

  • Tailwinds from a dovish Fed.
  • More risk-on sentiment after G20 Summit?
  • Accumulate on pullbacks.

Look back at how REITs performed during rate cut cycle

  • Due to the relatively short listing history of S-REITs, there was only one rate cut cycle where we can draw reference on how S-REITs performed when rates were going down. From Sep 2007 to Dec 2008, the Fed funds target rate (mid-point) was lowered from 5.25% to 0.125%. As this happened during the Global Financial Crisis, it was not surprising that the FSTREI fell 63% during that period. It goes to show that the underlying reason for the rates movement would be the driver of share price performance.
  • Looking at global REITs data which have a longer trading history, we use the S&P Global REIT Index (SREITGL) as a benchmark.
  • During the Fed rate cut cycle from Jul 1990 to Sep 1992, the SREITGL fell 13.1% due to recession and Iraq’s invasion of Kuwait. The next round of rate cut cycle occurred from Jan 2001 to Jun 2003, during which the SGREITGL actually rose 16.6%. The NBER determined the timeframe of the US recession from Mar to Nov 2001. A more prominent recovery in the price of SREITGL only took place in late 2002. Based on the Fed minutes in Nov 2002, there was robust underlying growth in productivity. This, coupled with the accommodative stance of monetary policy, could have driven the recovery in share prices.

Tailwinds from a dovish Fed but impact on DPU unlikely to be significant in near-term

  • Prior to Oct 2018, market concerns surrounded over the potential number of rate hikes in 2019. This perspective has since taken a 360 degrees turn as the softening macroeconomic backdrop and weak inflation data has led to growing calls for the Fed to cut rates instead. As such, the FTSE ST REIT Index (FSTREI) has delivered total returns of 21.6% YTD, strongly outperforming the STI.
  • The 3-month Swap Offer Rate (SOR) of 1.86% is at its YTD lows, but this would not have a significant impact on the DPUs of S-REITs given that REIT Managers have remained prudent in their capital management and have on average hedged ~80% of their total borrowings (for S-REITs under our coverage). That said, it remains possible that REIT Managers may choose to unwind some of their interest rate swaps upon maturity.
  • Our sensitivity analysis point to an average 1.9% increase in our DPU forecasts for a 100 bps decline in borrowing costs, with FAR EAST HOSPITALITY TRUST (SGX:Q5T), CDL HOSPITALITY TRUSTS (SGX:J85) and SUNTEC REIT (SGX:T82U) the biggest beneficiaries.

Acquisitions a potential catalyst but DPU accretion should not be taken for granted

  • We expect property cap rates to remain compressed in light of expectations that the Fed and ECB have a higher chance of cutting rates, coupled with ample liquidity in the markets. Thus, we believe a lower cost of capital from a lower risk-free rate and lower cost of debt need not necessarily translate into higher ease of making DPU accretive acquisitions.
  • Furthermore, with most S-REITs trading at a higher P/B multiple compared to a year ago, we also do not rule out the possibility of more equity fund raising activities to pare down debt, which would add downside risks to our DPU forecasts.
  • For now, as we look ahead, we are projecting FY-1 (FY19/FY20F depending on financial year end) DPU growth to come in at 1.7% (market-cap weighted) for the S-REITs under our coverage. This is expected to continue in FY-2 (FY20/FY21F), with projected DPU growth of 1.8%.
  • For FY-1, this would be driven largely by KEPPEL DC REIT (SGX:AJBU), CACHE LOGISTICS TRUST (SGX:K2LU) and CAPITALAND COMMERCIAL TRUST (SGX:C61U), while for FY-2, the main contributors to growth would come from Retail REITs, Hospitality REITs and KEPPEL DC REIT (SGX:AJBU) once again.

Potential rotation out of overcrowded defensive plays given progress on Sino-US trade situation

  • Positive developments on the Sino-US trade front during the G20 Summit over the weekend (agreement to restart trade talks and US agreeing not to increase existing tariffs on China) may turn the markets more risk-on (at least in the near-term) and this could lead to some profit-taking on S-REITs. However, if the impasse between the two superpowers happens during future negotiations, this could once again strengthen the case for defensive shelter themes and tighten yields further.
  • On an absolute valuation basis, S-REITs clearly look expensive. Forward distribution yield of the FSTREI has compressed to 5.3%, or 2.2 standard deviations (s.d.) below the 8-year average (6.3%). Forward P/B of 1.16x is 2 s.d. above the 8-year mean (0.99x).
  • From a relative basis, valuations of S-REITs appear slightly better given that the Singapore government 10-year bond yield has declined sharply, though the spread is still tight as compared to historical levels. As it stands, the forward yield spread between the FSTREI and the Singapore government 10-year bond yield is 330 bps. This is 1.6 s.d. below the 8-year mean of 423 bps.
  • From an individual REIT basis, we screened through our coverage, and based on Bloomberg consensus data, we noted that 13 out of the 21 S-REITs under our coverage were trading at forward distribution yields which were more than 1.5 s.d. below their 8-year mean (or maximum data points available if less than 8 years), while 11 of the 21 stocks had forward P/B ratios which were more than 1.5 s.d. above their 8-year average.
  • With expensive valuations amid overcrowded trades, we see risks from potential profit-taking, and recommend investors to accumulate during pullbacks instead. Based on current price levels, the only REIT with potential total returns of > 10% (including distributions) is ESR-REIT (SGX:J91U).
  • Our preferred names to accumulate on pullback are KEPPEL DC REIT (SGX:AJBU), FRASERS CENTREPOINT TRUST (SGX:J69U) and FRASERS COMMERCIAL TRUST (SGX:ND8U).

Maintain NEUTRAL, with a bias to the downside.

OCBC Research Team OCBC Investment Research | https://www.iocbc.com/ 2019-07-01
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