REITs - RHB Invest 2019-12-10: Expecting Moderation After An Eventful Year


REITs - Expecting Moderation After An Eventful Year

  • Remain OVERWEIGHT but prefer laggards.
  • The REIT sector outperformed strongly in 2019, and we expect it to remain in favour in 1H20 aided by persistent low interest rates and favourable demand-supply outlook. However, we expect investors to be more selective, and prefer the laggards (mainly in small/mid-cap space) with stock-specific catalysts.
  • Among sub-segments, our preference is for industrial, hospitality and US office REITs.

3 key factors supporting REITs in 2020

  • Expectations of a prolonged low interest rate environment,
  • inorganic DPU growth from the acquisitions made this year, and
  • benign supply outlook across most of the real estate sectors.
  • Additional factors that could provide tailwinds to REITS could be an increase in debt ceiling limit and interest cost savings.

Valuations high on a historical basis, but reasonable on a relative basis.

  • S-REITs’ average yield of 5.3% is still at a 350-bp yield spread to the Monetary Authority of Singapore’s (MAS) 10-year bond yield. While this is close to 1SD levels on a historical basis (10-year average mean of 400bps), it is still among the highest globally.
  • With the global interest rate outlook still remaining dovish, ample liquidity and uncertain market conditions, we believe interest in yield instruments are unlikely to see a sharp correction.

M&A trend likely to continue; acquisitions may take a breather.

  • 2019 was an eventful year in terms of acquisitions and fundraising, with S-REITs raising c.SGD6bn via the secondary market – the highest in any year.
  • Looking ahead, we expect acquisition-led growth to see a slowdown and REITs to focus more on asset enhancements and optimising portfolio returns from cost savings. REITs are also seen active in the M&A space with about six REITs undergoing a merger or having merged. We expect this trend to continue on the back of smaller REITs’ aspiration for scale and growth to narrow trading their trading discounts with larger ones, aided by lower interest rates.
  • Among sub-sectors, we see opportunities in industrial, hospitality and overseas REITs.

Review of debt ceiling limit a potential catalyst.

  • MAS is currently reviewing the S-REITs’ current gearing limit (from 45% to c.55%) with an outcome expected in 1H20. An increase in gearing limit could potentially lower REITs’ overall cost of capital by taking advantage of lower debt costs and aid in DPU growth.
  • S-REITs in general have been prudent in the current low interest rate cycle with average gearing at 35% and none exceeding 40% (despite the 45% threshold). The interest coverage ratio (sector) also remains healthy at 5.8x.

Key risks:

  • Change in interest rate outlook to hawkish, worsening of the US- impacting Singapore’s export-driven economy.

Industrial REITs – Market stabilising after a slowdown, demand remains the wild card.

  • Based on Jurong Town Corporation’s (JTC) latest industrial data, the industrial property market is showing signs of stabilising with overall occupancy at 89.3% (unchanged q-o-q, +0.2ppt y-o-y), and rental rising marginally by 0.1% q-o-q. While industrial supply is expected to jump to 1.9m sqm for 2020 (+46% higher than average supply in 2016-2019), about one-third of supply is for single-tenants for their own use and another 36% is meant for replacement for lessees affected by JTC’s industrial revolution programme.
  • Among sub-segments, multiple-user factory accounts for the bulk of 2020 supply (c.0.85m sqm), which should put pressure on rents and occupancies in this sub-segment.
  • On industrial demand, impact from trade tensions between the US and China has caused some drag-down effect in industrial leases, with longer lead time and downsizing in some segments. However, the market is showing some signs of a pick-up, with factory output increasing 4% y-o-y in Oct 2019, driven by healthy expansion in biomedical, general manufacturing and precision engineering sectors based on the latest Economic Development Board (EDB) data.
  • Similarly, the Purchasing Managers Index (PMI) in November also increased 0.2ppt m-o-m, boosted by faster expansion in factory output and inventory, and slower contraction in new orders, new exports, and employment. The order backlog index rose into expansion after 13 straight months in contraction.
  • EDB’s business expectation survey for (Oct 2019-Mar 2020) indicates that the majority (83% of surveyed firms) expect business conditions to remain similar over the next two quarters with impact from the US-China trade tensions being the key uncertainty and wildcard for demand growth. Overall, we expect industrial rents to remain flattish for 2019-2020 barring further worsening trade tensions.
  • Among the sub-segments, our preference remains the business & science parks and high-tech industrial segments which are likely to benefit from Government’s push to transform Singapore into a smart nation. ESR-REIT (SGX:J91U) (BUY, Target Price: SGD 0.60, report: ESR-REIT - Decent Quarter; Valuation Still Attractive) is our preferred pick due to its high exposure to the abovementioned segment (c.44%) and attractive valuations.
  • Although the logistics sector outlook remains challenging, we expect to see some stabilisation in 2H20. As such, we see CACHE LOGISTICS TRUST (SGX:K2LU) (BUY, Target Price: SGD 0.80) potentially gaining traction in the latter half of the year.

Hospitality REITs – On course for a multi-year recovery.

  • After a supply wave from 2013-2018 (c.4% pa), Singapore’s hotel supply situation will turn highly favourable for hoteliers with only about 1% pa supply growth over the next 3 years. The majority of the upcoming supply is also tilted towards the upscale/luxury segments located at the city centre, which should pose less of a direct competition to the listed REITs’ portfolios.
  • On the demand front, there are multiple catalysts ahead:
    1. Corporate demand for 2020 is expected to remain high on the back of a packed event calendar and meeting pipeline;
    2. Leisure travel demand has been on an uptrend on the back of improved airline connectivity, the Singapore Tourism Board’s (STB) active marketing efforts and potential travel diversions into Singapore, and we expect this trend to continue;
    3. Plans for large-scale tourism redevelopment over the next few years (which include Resorts Wold Sentosa/Marina Bay Sands expansion, Sentosa Brani Master Plan, Mandai makeover and Greater Southern waterfront) should help make Singapore’s hospitality scene more vibrant.
  • Overall for 2020, we expect visitor arrivals and hotel revenue per available room (RevPAR) to increase by 2-5% on the back of positive demand-supply despite market uncertainties.
  • CDL HOSPITALITY TRUSTS (SGX:J85) (BUY, Target Price: SGD 1.78, report: CDL Hospitality Trusts - Getting A Fresh Look; Maintain BUY) is our preferred pick for the hospitality sector.

Office REITs – Rent growth to moderate as demand outlook remains murky.

  • Office rent continued to be on an uptrend since bottoming out in 2Q17, with Grade-A rents up by nearly 28% from the bottom. However, the pace of rental growth has been moderating with 3Q19 at 1.3% q-o-q, impacted by the overall demand slowdown.
  • A key risk to office sector demand would be a sharp pullback in co-working office demand, which has been one of the key drivers of demand over the last four years. Other demand growth sectors which are expected to remain relatively resilient include the technology, media, telecommunications and financial sectors.

Co-working, a key demand driver, is likely to see a pullback.

  • Based on Colliers’ data, co-working office space has tripled since 2015 and stands at 3.7m sqf, or c.5%, of total office stock. In terms of distribution, 83% of flexible workspace resides in the central business district, 12% in the city fringe and 5% in the suburban area. WeWork is currently the biggest flexible space operator with 22% market share followed by IWG (16%) based on Colliers’ data.

Supply remains moderate.

  • Based on Coldwell Banker Richard Ellis (CBRE) data, total supply over 4Q19-2022 is estimated at 5.4m sqf, equivalent to 1.43m sqf pa, which is 24% lower than 10-year historical average of 1.88m sqf.
  • Overall, we expect office rents to continue on the uptrend, albeit at a slower pace of 2-5% for 2020. This should translate into healthy double-digit rental reversion for office S-REITs as the expiring rents are currently well below market rents (signed during recent office market bottom of 2016-2017).
  • SUNTEC REIT (SGX:T82U) (BUY, Target Price: SGD2.08) is our preferred pick for the sector.

Retail REITs – exit of popular brands a concern but limited supply ahead

Retail sales on a declining trend…

  • Based on the latest official data, retail sales fell 2.2% in September, the eighth straight month of y-o-y decline. Signs of strain in retail operators are also visible with the announced exit of popular retail operators like SaSa, DFA and downsizing of Metro retail stores.
  • The e-commerce threat remains limited for now with the segment accounting for only c.5% of total retail sales. However, the projected rising e-commerce trend and food delivery platforms (Food Panda, Deliveroo, GrabFood, etc) could pose medium-term challenges to retail demand.

...but minimal supply buffers the impact.

  • Based on CBRE data, the supply pipeline is expected to fall sharply to an average of c.0.22m sqf pa from 2020-2022. This is significantly lower than the 5-year historical average of 1.66m sqf. By sub-market, the outside central region and fringe area will account for the bulk (36% and 34.5% respectively) of future supply, with the downtown core, Orchard and the rest of central submarkets accounting for the remaining 8.2%, 10.3% and 11% of future supply respectively.
  • Amidst the above conditions, retail rents are expected to remain sluggish in 2020 (-2% to +2%), with malls having stronger attributes (location and catchment population) outperforming the weaker strata malls.

US Office REITs – Riding on the strong economic growth.

  • Among overseas REITs, we particularly like the US office REITs listed in Singapore as the fundamentals of the market remain sound on the back of continued office demand, underpinned by strong job growth and healthy corporate sector profits. Micro-market supply in which the US office REITs have exposure to also remains favourable. Other factors limiting supply growth are high replacement costs and prudent bank lending limiting supply.
  • One key risk for the sector, however, is the recent fallout in co-working operator WeWork, which is expected to rationalise its growth in the coming years. While co-working has been one of the key drivers of the demand in recent years, Colliers’ data indicates that the sector is still relatively small, accounting for only 1.8% of total office stock. US office REITs’ exposure to co-working players also remains small at < 3% of cash rental income – as such, we expect any potential impact to be limited.
  • Overall, we remain bullish on US-based office REITs listed in Singapore as they offer exposure to a market, which is benefitting from a strong rebound in the US economy and are still trading at attractive valuations.
  • MANULIFE US REIT (SGX:BTOU) (BUY, Target Price: USD1.00, report: Manulife US REIT - More Goodies To Come; Maintain BUY) is our Top Pick.
  • KEPPEL PACIFIC OAK US REIT (SGX:CMOU) (BUY, Target Price: USD0.88, report: Keppel Pacific Oak US REIT - Strong Rental Growth; Maintain BUY) is also trading at a very attractive valuation in our view, and should see a catch-up in terms of valuations in the near term.

More in attached PDF report: 

  • See attached PDF report for 
    • SREITs peer comparison table;
    • SREITs balance sheet & debt summary;
    • Listing of highest yielding regional REITs and more. 

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2019-12-10
SGX Stock Analyst Report BUY MAINTAIN BUY 2.080 SAME 2.080