Singapore REITs - RHB Invest 2020-04-23: Standing The Test Of Time; Keep OVERWEIGHT


Singapore REITs - Standing The Test Of Time; Keep OVERWEIGHT

  • Stay OVERWEIGHT; accumulate undervalued gems – Top Picks: Suntec REIT (SGX:T82U), ESR REIT (SGX:J91U), Manulife US REIT (SGX:BTOU).
  • SREITs recovered from March lows (+22% from bottom) as investors bottom fish for yields amidst an uncertain outlook. While REITs are expected to undergo near-term pain from sharply lower economic activity, the impact should be mitigated by locked-in leases and diversified portfolios. See S-REITs share price performance.
  • Amidst a hazy outlook and rapidly changing market conditions, we recommend investors to slowly accumulate undervalued REITs with strong sponsor backing, quality assets and operational track record.

Where are the REITs’ valuations now?

  • SREITs currently trade at 0.95x P/BV and offer average yields of 6.6% (550bps higher than the 10-year government bond) – slightly below mean. While headline valuations do not look cheap, we see selective opportunities in the REITs space as there is a huge disparity in valuation between the larger and small-mid cap REITs.
  • During the global financial crisis (GFC), SREITs touched a low of 0.4x P/BV and 12-15% yield levels. We believe REITs are unlikely to reach such levels, as they are much more diversified in terms of earnings and better equipped in terms of their balance sheets. Additionally, coordinated stimulus measures and ultra-low interest rates provide liquidity and downside support.

Recent policy move lowers equity fund raising (EFR) probability and boosts sector confidence.

  • The latest move to raise gearing threshold to 50% from 45% and the deferral of interest coverage requirement should help the REITs from an unanticipated breach of gearing limit and lower the probability of dilutive cash call.
  • SREITs have been relatively prudent in terms of borrowing in this cycle with the average sector gearing at 35.7%. As such, SREIT asset values have to fall by 17-44% before a potential breach, which we believe is a good buffer.

Expect near-term DPU cuts due to cash flow uncertainties.

  • The recent policy move to allow all tenants (except residential) impacted by COVID-19 to defer rents by up to six months and the extended circuit breaker period (until 1 Jun) have resulted in near-term cash flow uncertainties for REITs. This is likely to result in temporary cuts to quarterly DPUs.
  • Our estimate is that about 5-30% of tenants may opt to defer their rents with retail tenants that have been hard hit likely to make up the larger portion.

We like industrial REITs.

  • We see it as more defensive due to the inability to carry out operations remotely, lower rental base, and lack of substitution choices for industrial tenants. This is followed by office, hospitality, and retail REITs.
  • While investors are likely to shun hospitality REITs until a clearer picture emerges, we see room for a sharp rebound, as they are currently trading at low valuations.
  • Retail REITs remain our least preferred sector, as we believe the current crisis could potentially accelerate structural headwinds this sector faces.

Industrial REITs – Still the backbone of Singapore’s economy

Industrial rent to decline by 2-5% in 2020.

  • Industrial sector rent, which has been on a stabilisation trend lately, is expected to come under pressure with the Ministry of Trade and Industry (MTI) forecasting a GDP decline of -1% to -4% for 2020 on the back of COVID-19. Not surprisingly, Singapore’s Purchasing Managers’ Index (PMI) posted a 3.3-pt drop from the previous quarter to 45.4, the lowest reading since Feb 2009. The electronics sector PMI registered a 3.5-pt decline to 44.1, also the lowest since Feb 2009.
  • While the outlook looks grim, we expect industrial sector occupancies and rents to be relatively resilient compared to other sectors. This is as there is limited scope for industrial operations to be carried out remotely, lower rental base for industrial sector, and lack of substitution choices.
  • Cushman & Wakefield, in its recent industrial sector outlook noted that the majority of industrial firms have shelved their plans to relocate and renewed the current lease instead to avoid incurring additional capex requirements. It added that location will be a big factor in determining rental growth of different micro markets during COVID-19 and expects factory rents and better quality industrial buildings to be more affected due to their outlying locations.

Government support schemes to ease some pressure.

  • The Government, in its three-pronged budget, announced various schemes which we believe will temporarily ease a fair bit of near-term cash flow pressure on industrial tenants (especially SMEs). These are: Jobs Support Scheme (JSS) (which provides wage offset), ease of labour cost for employees by waiving monthly foreign worker levies, enhanced financing support (with the Government taking 90% of risk share of a loan) as well as enhanced rent waivers and property tax rebates.

Industrial rent deferrals likely to be low.

  • Based on our discussions with various industrial landlords, there has been no noticeable increase in tenant defaults or an increase in late payments so far. The impact of the latest government announcement that allows tenants to defer rent up to six months is likely to be low, in our view, as industrial tenants are generally more long-term oriented. Even if a tenant choses to defer, the landlord has 3-4 months of security deposit which can used as an offset.
  • Our view is about 10-20% of impacted SME tenants may choose this option, while landlords, if they see merit and tenant ability to survive, may work with the tenants during this period.

More government support to industrial sector likely if COVID-19 prolongs.

  • The manufacturing sector still forms the backbone of Singapore’s economy, accounting for 21% of the country’s GDP in 2019. We believe the Government has various policy measures and tools at its disposal to support the industrial sector, should the economy enter into a prolonged recession.

Supply pressures mitigating after 2020.

  • While industrial supply is expected to jump to 2.2m sqm for 2020 (50% higher than average supply in 2016-2019). The supply is more tilted towards factory space. About 40% of the supply is for single-user factory space (typically for own use). Another 40% of the supply is in the multiple-user factory space, of which about 50% is intended for replacement leases that are affected by JTC’s industrial revolution programme, while the remaining 20% is for the warehouse and business park space.

Business parks and high-tech industrial remain our preferred sub segments.

  • Among the sub-segments our preference still remains for business & science parks and high-tech industrial segments, which we expect to be less impacted by COVID-19 and benefit from the Government’s longer term push to transform Singapore into a smart nation.
  • ESR REIT (SGX:J91U) (BUY, Target Price: SGD0.50) is our preferred pick due to its high exposure to the above mentioned segment (~44%) and attractive valuation.
  • While Ascendas REIT (SGX:A17U) (NEUTRAL, Target Price: SGD3.00) is likely to be the most resilient industrial stock under our coverage as its current valuation is not attractive to us.
  • Although the logistics and warehouse sector outlook still remains challenging, we expect to see some stabilisation in 2021. The sector should also see some benefit from an increased warehouse and logistics demand due to COVID-19. Thus, we see Cache Logistics Trust (SGX:K2LU) (BUY, Target Price: SGD0.74) potentially gaining traction in the latter half of the year.

Office REITs – On hold for now

  • We expect office rents to come down by 5-10% in 2020 after a steady rise of nearly 28% since bottoming out in 2Q17. The impact of COVID-19 has yet to be felt on office rents with CBD Grade-A rents remaining flat q-o-q at SGD10.09 psf in 1Q20 while Grade-B rents saw a modest 0.3% q-o-q decline, according to Colliers. Leasing demand for 1Q20 was driven by the technology, media and telecommunications (TMT) as well as coworking space sectors. Overall vacancy for CBD Grade-A office space also tightened by 30bps q-o-q to 3.1%.
  • For the rest of the year we expect leasing momentum to slow down considerably as office tenants assess the impact of COVID-19 on their businesses and are likely to be cautious in any expansion plans with some right sizing and relocations expected.
  • More importantly, co-working space operators, one of the key office drivers over last three years, is likely to take a pause and scale back on its expansion plans with early signs of troubles at WeWork. However, demand for technology, telecommunication, digital media solution providers and pharmaceutical tenants is likely to remain on an uptrend.

Supply remains moderate, buffering some of the impact.

  • Based on CBRE data, total supply for 2020-2023 is estimated at 5.1m sqf, equivalent to 1.3m sqf pa, which is 31% lower than the 10-year historical average of 1.88m sqf. Under current market conditions, we may also see many developers push back on some of their construction plans, which should help mitigating rental declines.

Lower expiring rents and government support measures to alleviate some pressure off office REITs.

  • While outlook for the office sector remains negative in the near term, the impact on office REITs is mitigated as:
    1. Expiring rents for office leases on average are 10-20% below market rents as most of the expiring leases were signed before the current office market recovery in 2016-2017, which allow landlords to lower rent and retain tenants. Tenants may also choose to extend their leases in the same premises at lower rent rather than moving location and incurring additional costs unless a much cheaper alternative emerges. This, in our view, provides some downside protection;
    2. The Government has also provided direct relief for office tenants on two fronts – 30% property tax rebates and JSS. The former is mandated to be passed on tenants. Based on our estimates this translates to c.0.25 months’ rent rebates to the tenants. Additionally, JSS, which was rolled out in the budget, provides direct offset to employee wages to all firms, will help in reducing retrenchment and thus hold up office demand to a certain extent.
  • Overall, we expect office landlords with minimal near-term lease expiry and assets at prime locations to be in a better position to weather this crisis.
  • Our pick is Suntec REIT (SGX:T82U) (BUY, Target Price: SGD 1.78) on valuation and asset quality basis.

Hospitality – a major speed bump

  • Among SREITs, the hospitality sector has taken the most direct hit with global travel coming to an almost grinding halt. Based on Singapore Tourism Board’s (STB) data, the average hotel occupancy for Singapore hotels in February fell to 51% (vs 89% last year), with hotel sector RevPAR down 41%.
  • STB in early February estimated visitor arrivals to drop 25-30% for 2020 but we see further downside risks to this forecast with no clear visibility on when the travel ban will be lifted. However, we see few mitigating factors that are in place that should help Hospitality REITs tide through this very difficult period:
    1. Master leases and minimum guarantees. Most of the hotels in the REITs are operated on the basis of master leases with minimum guarantee rent structure in place, which offer downside protection for REITs investors;
    2. Stay-Home Notice (SHN) to provide some relief. Many of the hoteliers including hotels under the REITs have tied up with the Singapore Government to accommodate persons, who are issued a 14-day SHN. These are mainly issued to returning overseas citizens (nearly 40,000 issued) and has helped hoteliers maintain reasonable occupancy levels (estimated 50-60%) during these uncertain times;
    3. Government support measures. Based on latest supplementary budget, qualifying commercial properties (such as hotels, serviced apartments, retail sector) will now receive 100% property rebates compared to 15-30% previously The increased rebates will help Singapore-based hospitality players to cushion some of the sharp negative impact to their earnings caused by COVID-19. In addition, 75% wage support will likely ease the pressure on operating costs mitigating NPI decline.

Possibility of supply being pushed further back.

  • Hotel supply remains minimal with a supply growth of 1% pa over the next three years, compared to about 4% pa during 2013-2018. With the possibility of the travel ban in place for a longer period, we believe many of the hoteliers could also push back near-term supply.
  • Majority of the upcoming supply is also titled towards the upscale and luxury segments located in the city centre, which should pose less of a direct competition to the listed REITs portfolio.

Mid-to longer-term catalysts remain intact

  • Over the mid-term, plans for large-scale tourism redevelopment over the next few years – Resorts Wold Sentosa and Marina Bay Sands expansion, Sentosa Brani Master Plan, Mandai makeover, and Greater Southern waterfront – should help make Singapore’s hospitality scene more vibrant.
  • Overall, we believe investors are likely to stay on the side lines for hospitality sector until some clarity emerges on how long this situation is likely to prolong, and when the travel ban is likely lifted.
  • Our post recovery pick on the hospitality sector remains CDL Hospitality Trusts (SGX:J85) (NEUTRAL, Target Price: SGD1.03, see report: CDL Hospitality Trusts - RHB Invest 2020-04-20: A COVID-19 Curveball).

Retail REITs – COVID-19 to accelerate structural challenges

Covid-19 is likely to accelerate e-commerce and food delivery trends.

  • The retail sector, in our view, is likely to see the biggest long-term impact from COVID-19, with the lockdown forcing many retailers to turn towards an omni-channel strategy. It could also tip many consumers into the convenience of e-commerce and food delivery options thus accelerating some of the long-term challenges for the sector.
  • Early signs of this trend were visible – online sales as a proportion of overall sales accounted for 7.4% of total sales for February compared to the typical 5-6% levels. Even before the pandemic, signs of strain on the retail segment were visible, with the exit of major retail tenants ie SaSa and DFS, as well as the downsizing of Metro retail stores.

Rent rebates and government measures to prevent a sharp spike in near-term mall vacancies.

  • The extended circuit breaker measures in Singapore, announced on 21 Apr, have brought physical retail activities to a complete halt except essential services like supermarkets, restaurants (only takeaways allowed) and pharmacies. To mitigate the impact on tenants, retail REITs are currently providing about 1.5-3 months rental rebate for tenants, of which about one month is derived from the property tax rebates offered by the Government.
  • In addition, landlords are also seen to be offering various marketing package and providing cash flow relief by releasing security deposits. This, in addition to wage support packages (up to 75%), should help in providing some buffer to cash flow issues faced by retail tenants (especially the F&B sector) and potentially reduce the risk of a sharp rise in mall vacancies.

Retail REITs cash flow to be impacted by the new law to help tenants.

  • The new law, which allows tenants to defer rent up to six months, is expected to hit retail landlords the hardest in terms of cash flow as small retail tenants (particularly F&B tenants) may choose to defer their rent due to the lack of revenue. Coupled with additional rent rebates and additional marketing expenses, this is expected to create cash flow uncertainty for REITs and likely to result in near-term DPU cuts by REITs until visibility emerges.

Limited oncoming supply.

  • Based on CBRE data, supply pipeline is expected to fall sharply to an average of 0.22m sqf pa in 2020-2022. This is significantly lower than the 5-year historical average of 1.66m sqf. By sub-markets, the outside central region (36%) and fringe areas (34.5%) will account for the bulk of future supply, with The Downtown Core, Orchard, and rest of the central submarkets accounting for the remaining 8.2%, 10.3% and 11.0% of future supply.

Prefer sub urban malls on dips.

  • Overall, we expect retail rents to drop by 5-10% in 2020, with suburban malls and malls catering to necessity spending to outshine high-end ones.
  • Frasers Centrepoint Trust (SGX:J69U) (NEUTRAL, Target Price: SGD2.55) remains our preferred pick.

Overseas REITs – separating the wheat from the chaff

  • Among overseas REITs, our preference is for the office sector due to the long WALE and tenant quality, which should provide relative resilience in current market conditions.

US office REITs likely to stand the test of time.

  • While US office demand is likely to see a sharp slowdown on the back of the Covid-19 pandemic, the impact to US office REITs are mitigated by several factors including long WALE (above four years) and limited lease expiry in 2020 (below 7% of total); a diversified portfolio of assets and tenants; as well as relatively sound balance sheet with minimal debt maturing in the near term.

Limited direct exposure to co-working segment.

  • One key risk for the sector, however, is the recent fallout in co-working operator, We Work, which is expected to rationalise its growth and understood to be working with some of its landlords on renegotiating terms for some of its leases. US office REITs’ direct exposure to co-working players remains small, below 2% of cash rental income.
  • Our picks for US office REITs are Manulife US REIT (SGX:BTOU) (BUY, Target Price: USD0.88) and Keppel Pacific Oak US REIT (SGX:CMOU) (BUY, Target Price: USD0.76).

We also like IREIT Global for its stable income profile and strong sponsors.

  • IREIT Global (SGX:UD1U) (BUY, Target Price: SGD0.83) derives the bulk of its income from German assets, mainly anchored by two key tenants – Deutsche Telekom and Europe’s largest pension fund, Deutsche Rentenversicherung (DRV) – which we see as relatively sticky and account for c.77% of its rental income. Also only 2% of total leases are expiring until 2021 providing income visibility. The recent increase in stake by the sponsor and strategic investor demonstrates confidence in IREITs assets and its long-term growth plans.

Read also SGX Market Update: New Significant Supportive Measures for S-REITs

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2020-04-23
SGX Stock Analyst Report BUY MAINTAIN BUY 1.780 SAME 1.780