Singapore REITs - DBS Research 2020-03-03: Knocked Down But Not Knocked Out


Singapore REITs - Knocked Down But Not Knocked Out

  • Broad based indiscriminate sell-off an opportunity for investors to accumulate.
  • Industrial, selected office and suburban retail S-REITs better placed to survive a “U-shape” recovery as expectations are dialed back.
  • Good value in hospitality S-REITs - Ascott Residence Trust (SGX:HMN) and Far East Hospitality Trust (SGX:Q5T) supported by high proportion of fixed rents.
  • Watch for potential structural changes in the office, warehouse and retail space in the medium term.

Broad-based sell-off typically a good time to accumulate.

  • The recent price weakness in the past week and broad-based sell-off on Friday have brought prices of S-REITs down by 6.5% (1 week) and 5.6% compared to the start of the year. Average sector yields have risen back to c.5.5%, implying a spread of over 4.0% against the Singapore 10-year bond yields.
  • We see the broad-based sell-off as an opportunity to accumulate S-REITs on expectations that the low interest environment and high headline yields will attract investor interest back to S-REITs after the market stabilises.
  • See S-REITs share price performance

Surviving “U-shape” rather than “V shape” recovery.

Value in the hospitality REITs.

  • Though the time may not be ripe, hospitality S-REITs have borne the brunt of the sell-off and are now trading at -1 standard deviation of their historical 5-year P/NAV mean.
  • We believe that negatives are likely priced in and see opportunities for Ascott Residence Trust (SGX:HMN) and Far East Hospitality Trust (SGX:Q5T) at current levels given the high proportion of fixed revenues which would support yields of c.5.0%. Strong Sponsor support provide us with comfort that these fixed rent obligations are likely to be paid.

Potential structural changes in the longer term.

  • After the dust settles, we see potential trends emerging:
    1. Enabled by technology, more firms embracing flexible working arrangements (or work from home) after recent business continuity plan (BCP) episodes resulting in a smaller office real estate needs, and
    2. stronger demand for warehouses as demand for online purchases (especially within the food & beverage (F&B) space as consumer habits change after a period of adjustments.

US treasury yield at multi-year low implies heightened economic worries; but S-REITs usually rebound stronger after.

Risk of economic slowdown led to outflows in S-REITs.

  • The market likes low yields but does not like them to be too low. Sounds like a little too much to ask. Our observation is that with the 10-year US treasury yield (UST) now at a multi-year low at c.1.3% with the SG 10-year bonds close behind at 1.5%, we believe that these levels represent heightened worries of an economic fall-out, outweighing the attractiveness of the yield spread that the S-REITs offer.
  • Over time, we feel that investors tend to be more comfortable when 10-year yields range c.1.5%-c.1.8%, which seems to be the sweet spot for the markets and S-REITs (goldilocks economy) rather than at current levels.
  • We also note the flattening of the yield curve similar to Aug- Sep’19. Back then, there was similar concerns of a recession which saw a sell-off in the REITs. If history is repeated, such selloffs are good opportunities to accumulate as this does not last and S-REITs tend to bounce back stronger.
  • The immediate catalyst is if the FED cuts rates in March-20, which will provide some respite to yield stocks like the S-REITs.

What should we buy after this sell-off?

S-REITs usually stage a rebound as investors remain attracted to its yield.

  • The broad-based sell-off in S-REITs of up to 4-5% in a day is certainty noteworthy which can be explained by funds outflow, which tends to be broad-based in nature. With S-REIT prices still higher on a year-to-date (YTD) basis, we do not rule out near term share price weakness in the immediate term from outflows.
  • Looking at various subsector performances, we note that industrial REITs have held up better, which we believe is due to the sector’s perceived stability and higher relative growth prospects, while the more economic sensitive sectors - hospitality and office and even retail - have been hit given the economic uncertainties brought about by the COVID-19 outbreak.
  • S-REITs remains a core investment sector; implies that flows will return over time. In the medium term, we believe S-REITs will continue to be an important and relevant component of investors’ portfolio, especially given the sector’s increasing representation in major indices (current and future) such as the MSCI, STI, EPRA Nareit Developed World Index.
  • Coupled with high yields of 5.5%, investors will eventually be drawn back into the S-REITs sector.

Impact of COVID-19.

  • Investors are now faced with an increasing risk that the COVID-19 outbreak may be more prolonged than initially expected and have varying impact on the sector. Our preference remains the industrials (notwithstanding valuations still high on a relative basis) for their longer weighted lease expiry (WALE) supporting distributions, and selected office REITs (including US office REITs) as potential acquisitions may drive distributions higher.
  • Within other sub-sectors (retail and hospitality) that are directly impacted, we believe suburban retail landlords (CapitaLand Mall Trust and Frasers Centrepoint Trust) should fare better in a “U-shape” recovery given their asset positioning that caters to consumers’ daily necessities and location within high density residential areas.
  • In fact, feedback from landlords is that traffic is returning (before we see a pick-up in sales) and with retail REITs trading at c.5% yields, we may potentially see bargain hunters returning at current levels.

Hospitality - for the brave to start nibbling.

  • Most interesting is the hospitality sector, which is now trading at -1 standard deviation (-1 SD) on a 5-year P/NAV basis, and has most likely priced in most of the negatives. Feedback among hoteliers indicate that occupancy rates across hotels are at the 50%+ level, meaning that the worst may not be as bad as initially feared.
  • While timing may not be the most appropriate at this juncture given the clouded outlook, investors can look to nibble into hospitality S-REITs such as Ascott Residence Trust or even Far East Hospitality Trust given the high fixed rents (up to 70% of revenues) which limits downside risk.
  • Assuming zero variable income, Ascott Residence Trust and Far East Hospitality Trust are projected to still deliver yields of up to 4.7% and 4.9% respectively, based on current prices.

Structural trends to emerge in the longer term?

  • During this period, some firms have activated their business continuity plans (BCP) and split their workforce into half in the past month. We believe that in the longer term, more firms may consider work-from-home (WFH) or embrace flexible working arrangement practices. This may mean that demand for office space over time may moderate. In response, landlords may restructure leases or their floor plates to offer a higher percentage of flexible office offerings in the longer term.
  • Within retail and hospitality, we believe that there could be more e-commerce activity (including food & beverage) as consumers start to embrace deliveries while more video conference facilities may over time result in less business travel.
  • See subsector analysis and picks in attached PDF report by clicking view full report button below.

Derek TAN DBS Group Research | Rachel TAN DBS Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2020-03-03
SGX Stock Analyst Report BUY MAINTAIN BUY 1.500 SAME 1.500