Singapore REITs - DBS Research 2020-03-18: Great Singapore Sale


Singapore REITs - Great Singapore Sale

Singapore REITs: The sale you have been waiting for

  • We believe that the potent mix of fund redemptions and unwinding of leveraged positions has resulted in the indiscriminate selling of S-REITs. The price of S-REITs has now retreated by c.25% from the peak in Jan 2020, in line with the Straits Times Index (STI).
  • While their fundamentals may weaken on the back of the Covid-19 outbreak, we believe that the sell-off is not warranted. When the dust settles, we believe investors will refocus back on
    1. now attractive yield spreads, at north of 5% (+1SD of its 10-year mean),
    2. lower for longer 10-year bond rates that will lend support to higher share prices in the medium term.
  • The indexation potential for a selected group of S-REITs by 2H20 may lead to a rebound in prices.

Flows over fundamentals.

  • The share price carnage seen in the S-REITs space of the last two weeks brought back memories of the period during the 2007-2008 GFC. Like in 2008-2009, we are currently seeing fund outflows from the S-REITs prevailing over fundamentals.
  • In our view, it is “who owns what” that matters for now as a potent mix of fund redemptions and reversal in leveraged positions has resulted in investors heading for the exit in the near term. This has resulted in a significant dip in S-REIT prices.
  • Since peaking at the end of Jan 2020, the S-REIT index (FSTREI Index) has declined by c.22% which is in line with the drop in the Straits Times Index (STI) from its peak in Dec 2019. See Share Price Performance - S-REITs Sector.

Where to look for opportunities when revisiting this sector?

  • While S-REITs are currently trading at an average sector yield of close to 6.5% with a yield spread of close to 5% vs. 10- year government bond yields but with uncertainties stemming from potentially rising outflows from the sector as the cost of equity rises owing to potential downside risks to the economy, we are looking for a potential change in fair values to price in such risks.

How did S-REITs perform in times of recession?

A steep decline back in 2009; but never to be seen again.

  • Looking back at the GFC, we found that S-REITs plunged by a significant 70.6% during the 2008-2009 GFC – which is similar to the 69.2% retreat for the developers’ index of FSTREH – both underperforming the 57.6% drop in the STI Index. The drop is more gradual and over a longer period of 21 months compared to the STI Index’s 17-month decline.
  • In our view, the steeper drop in the FSTREI can be explained by
    1. the S-REIT sector’ first crisis within six years of its conception, and
    2. a credit-driven recession as S-REITs are dependent on credit to a certain extent.
  • Since then, the sector has weathered through many global uncertainties over the past 10 years and has maintained its outperformance relative to the STI.
  • Given the improved stability of S-REITs, we noticed that the degree of the share price retracement of S-REITs has diminished in times of economic stress over the past couple of years, with the exception of 2013, which was driven by a reset of interest rate expectations. While we expect price volatility in the near term, we believe that S-REITs can maintain their outperformance relative to the STI.
  • In terms of relative performance back in the 2007-2008 GFC, we noticed that industrial REITs and retail REITs had fallen to a lesser extent than the FSTREI, which we attribute to the two subsectors’ income and earnings stability.
  • On the other hand, office and hospitality S-REITs had declined by a larger % relative to the FSTREI, owing to their more cyclical earnings.

Contrasting fortunes for S-REITs.

  • In our view, S-REITs are faced with contrasting fortunes – firstly with global rates anchored at new lows (with 10-year government bond yields projected to remain at c.1.1%-1.2% in 2020-201) vs. our previous estimate of 2.5%, a yield spread of close to 5% remains attractive for investors seeking exposure to S-REITs.
  • That said, we believe that there is also a need to readjust the risk premia for S-REITs as we move along the economic market cycles. We anticipate this to surge given expectations of a slowdown in economic growth and its impact on the various real estate sectors, with an economic recession in 2020 a rising possibility.
  • Using the GFC as a guide, the average sector betas could surge by 20bps (ranging from 18bps to 30bps) during times of economic stress.
  • In our scenario analysis, if we
    1. assume an average hike of 20bps in discount rates, and
    2. reset the risk-free rate to 2.0% vs. 2.5% currently, we project up to a 16% to 35% cut in fair values.
  • See tables in attached PDF report for details.

Credit metrics have improved since 2009-2010

  • The 2007-2008 GFC had been brought about by a credit crunch, which was a painful lesson for S-REIT managers. Since then, we found that S-REITs’ overall balance sheet and credit metrics have improved in contrast to the onset of the crisis in FY08 vs. FY19.
  • It is worthy to note that the average portfolio encumbrances have declined to c.15% from 26% back in the GFC period, which implies more financial flexibility for S-REITs to collateralise their portfolio, if the need arises.
  • Secondly, we note that valuations may fall during times of crisis and this could drive S-REITs’ gearing higher. However, we do not expect large-cap REITs’ gearing to be largely impacted.
  • During the GFC, we note that some S-REITs’ valuation fell by c.5%. Based on this, we estimate that gearing would increase by c.2ppts if the asset value falls by c.5% – with most of the large-cap S-REITs’ gearing still below 40%. MAS’ consultation paper of raising the gearing limits of SREITs could help mitigate this risk.
  • In addition, the distributable income/1-year debt commitment of 1.0x implies that in the worst-case scenario, S-REITs will generate enough cashflows / distributions to pay off their near-term debt obligations (an unlikely scenario), thus demonstrating the solid financial position of S-REITs.

Retail and Industrial S-REITs occupancy rates more resilient in times of economic stress

  • 2020 remains another year of growth for S-REITs. While the underlying growth in net property income in 2020 is driven by a mix of acquisitions and organic growth, we draw comfort from the fact that S-REITs can still deliver growth in distributions in 2020 after a robust year of accretive-acquisition growth. While we do see certain risks emerging for the hospitality and retail subsectors given downside risk to occupancy rates and rentals, we do not anticipate large revisions to our DPU growth estimate of 2.7% for S-REITs in 2020.
  • Among the various sectors, we anticipate downside risks to our retail S-REIT estimates given the potential rebates offered by retail landlords to tenants (we had estimated previously that the subsector’s DPU could drop by up to 5%) while hospitality S-REIT estimates could be slashed even more given the fast deteriorating operational outlook, especially in the near term.
  • Occupancy levels fairly sticky in times of crisis. Tracking the historical occupancy rates of the various S-REITs, we found that the occupancy of the retail and hospitality subsectors dipped more quickly than the other subsectors – i.e. falling by 1.6ppts and 0.9ppt. However, the occupancy of the hospitality and office subsectors fell more than the subsectors over the period and peaked in Mar 2009, when the FSTREI Index bottomed one quarter after GDP growth bottomed. The hospitality and office subsectors’ occupancy fell by 8.9ppts and 2.6ppts q-o-q in 1Q2009 to the lows of 75% and 93% during the GFC respectively. While the retail sector reacted more quickly, its occupancy only fell to a low of 98% during the GFC.
  • Occupancy in the industrial subsector was relatively most stable compared to the other subsectors. Industrial S-REITs’ occupancy rates (Ascendas REIT (SGX:A17U) and Mapletree Logistics Trust (SGX:M44U)) dipped by more than > 1ppt only towards the end of the 2008-2009 GFC, from close to c.99% in 2H2009 to a low of 97% occupancy post the peak of the GFC. As such, these data further drives through our point that the performance of the retail and industrial subsectors will be more resilient in times of economic stress.

Repricing risk – a scenario analysis.

Derek TAN DBS Group Research | Rachel TAN DBS Research | Singapore Research Team DBS Research | https://www.dbsvickers.com/ 2020-03-18
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