Singapore Industrial REITs - DBS Research 2020-12-04: Year Of Reckoning


Singapore Industrial REITs - Year Of Reckoning

Industrial sector to have excess supply in 2021.

COVID-19 both boon and bane for industrial sector.

  • The COVID-19 outbreak and subsequent Circuit Breaker measures in April-May 2020 led to the plummeting of leasing activities in the second quarter of 2020. The Singapore government stepped in to implement rent waivers and deferments to assist businesses that have been severely affected by the pandemic.
  • Landlords also did their part and provided rental assistance to firms who were impacted by the COVID-19 pandemic. This led to the unprecedented move by many industrial S-REITs to make provisions and conserve cash to prop up cashflows and pre-empt potential defaults in 1H20. This was especially so for industrial S-REITs with a larger exposure to Singapore as well as a larger exposure to small and medium enterprises (SMEs).

Supply spike rolled over from FY20 to FY21.

  • As the construction sector is not an essential service, works had to be stopped during the Circuit Breaker period. Furthermore, the high transmission rate of the virus within the foreign workers’ dormitories led to extended work stoppages. Although it dealt a blow to the construction and industrial sector, it also led to a much-needed breather for industrial landlords.
  • The extended stoppage in construction works is expected to delay the completion of c.0.7m sqm of new industrial supply in FY20. Only c.0.9m sqm of new industrial supply is expected to come online in FY20. This allowed landlords to maintain occupancy and ease downward pressure on rentals.
  • The rollover of c.0.7m sqm of new supply to the next two years implies that c.2.2m sqm and c.1.5m sqm of new space will be added to supply completion projected in FY21 and FY22 respectively. This is significantly higher than the average annual demand and supply of industrial space that were both at around 0.8m sqm in the past three years.
  • According to JTC, the c.2.2m sqm of new industrial property supply in FY21 will be the largest new supply added to the sector in a single year since it began tracking this data in 1998. Multiple-user and single-user factories will be the largest contributors at c.40% of new supply each in 2021. c.12% of the new supply is attributed to warehouses, and the remaining 8% is from the business park segment.

Overall market rental growth tempered by excess supply situation.

  • According to JTC, single-user factory space is usually developed by industrialists for own use and approximately half of the new multi-user space will be taken up by tenants who have been displaced due to JTC’s Industrial Redevelopment Programme.
  • However, with economic sentiments remaining soft and uncertainties still looming, we believe that occupancy and rental rates for the various industrial property segments will face further pressure. Businesses may hold back expansion plans and cut down on existing space, which could lead to the emergence of shadow space. Older industrial properties in less ideal locations will face more pressure than newer modernised properties that are served by better amenities.
  • However, the biomedical, technology, precision engineering and logistics sectors are still expected to remain robust going forward. This bodes well for selected industrial property types such as business parks, high-specs and modernised logistics facilities.

Industrial S-REITs well positioned to capture growth from the “new economy” sector

Manufacturing sector is turning a corner; selected trades will pull ahead.

  • Despite the uncertain outlook and muted economic activity, Singapore’s manufacturing Purchasing Managers' Index (PMI) reported a surprise expansion just one month after the Circuit Breaker measures were lifted. The October PMI reading was the fourth month of consecutive expansion and the highest reading since March 2019. The electronics sector PMI also continued its expansionary path and was the highest in slightly over two years.
  • However, as Singapore’s economy is highly reliant on international trade, the ongoing COVID-19 pandemic and geopolitical tensions could hamper Singapore’s manufacturing expansion. Respondents to a survey on future business conditions noted that general manufacturing, biomedical manufacturing, precisions engineering and transport engineering are expected to continue reporting healthy expansions. However, the electronics and chemicals sectors are expected to face some pressure, and employment sentiments remain weak.
  • The discovery of potential vaccines for the COVID-19 virus could lead to a faster-than-anticipated rebound of global economies. As a regional hub for international trade, Singapore will benefit from additional foreign direct investments (FDIs) that could further lift its manufacturing industry.
  • Outperformance of the sector and a strong take-up rate for light industrial and general manufacturing properties will be an upside surprise to our projections.

Industrial REITs to ride on growth sectors.

  • On average, the majority of industrial S-REITs’ tenants are from the Technology, info-comm, biomedical, healthcare, consumer goods, logistics and distribution sectors. We expect these sectors to see healthy growth rates in FY21 as economies rebound from the COVID-19 pandemic. The technology and biomedical sectors are expected to continue outperforming other industries.
  • We believe that the business climate for the commodities, marine and aerospace industries are less positive with industry outlook remaining impaired. We could see more downsizing and consolidation among firms in these sectors. However, industrial S-REITs’ exposure to these sectors are limited and we believe that any potential impact to their portfolios will be contained.
  • See the breakdown of industrial S-REITs' exposure by tenant industry subsectors in the PDF report attached below.

Business parks and high-specs industrials remain the preferred asset class

Singapore is Asia’s emerging hub for deep tech, a driver for high quality industrial and business park properties.

  • Singapore’s advanced IT infrastructure, strong government support, strong intellectual property laws, and deep talent pool has made it into an emerging tech hub. In addition to attracting consumer-focused tech start-ups, Singapore has been luring more deep tech start-ups. In the first half of 2020, tech start-ups in Singapore have raised S$3.3bn in investments. Total investments in FY20 is expected to exceed the S$6.5bn raised in FY19.

Outlook for business parks and high-spec properties remain favourable.

  • While the overall industrial property sector will be facing headwinds due to the projected spike in upcoming supply, we favour the business parks and high-specs industrial property segments. Both segments should continue to see healthy take up from the biomedical, technology and precision engineering industries. Demand from these industries and limited new supply will continue to support both property segments.

Precision engineering sector grew 11.4% in 1H20; driving demand for the high-specs space.

  • Despite the economic contraction due to the COVID-19 pandemic, Singapore’s precision engineering sector grew 11.4% (y-o-y) from January to July 2020. The slowdown in the marine and aerospace sectors have been more than compensated by the growth in the semiconductor, medical technology and data centre sectors.
  • Biomedical and medical technology continue to be integral sectors, while the adoption of 5G network and telecommuting will power the growth of the semiconductors and data centre segments. Due to limited new supply of high-tech facilities, we expect this segment to remain resilient and report healthy occupancy and rental rates.
  • We have noted that the industrial S-REITs have taken incremental steps in pivoting towards these assets classes to support the expected growth in these industries. Apart from looking at acquisitions which may be tough to come by in Singapore, we have noted that a common strategy is to redevelop their existing portfolios and repurpose them into higher specifications properties. This widens their appeal to more firms and attracts more value-added manufacturing firms to their portfolios.
  • See the summary of recent redevelopment projects by industrial S-REITs in PDF report attached below.

Business park properties to benefit most from Singapore’s future.

  • Singapore continues to attract other forms of FDIs in the research and development (R&D) and pharmaceutical fronts. Some of the more noteworthy FDIs in 2020 include expansion plans by Thermo Fisher Scientific Inc., Hyundai Motor Group, and Procter & Gamble despite the pandemic. We expect these FDIs and expansions to mainly benefit business park properties and, if any, the high-specifications space. Within the business parks subsector, we believe that business parks located in the city fringe or in the Jurong Innovation District to appeal most to these multinational companies (MNCs).
  • New supply of business park space has been limited in the past few years and this has supported the occupancy and rental rates. More specifically, city fringe business parks that are served by better amenities such as the Buona Vista, and Harbourfront and Alexandra clusters have been reporting higher occupancy rates of 91% and 89% respectively.
  • Despite the addition of some new supply in both clusters in the past two years, take up rates have been keeping pace. Net absorption at the Jurong and Changi clusters have been negative over the same period as we believe tenants have been consolidating and likely relocating to more centrally located clusters. However, as the Jurong Innovation District takes shape and surrounding infrastructure develops, we believe that the Jurong cluster will gradually be able to report better occupancy rates.

New supply of business parks in FY21 has been mostly pre-committed.

  • According to JTC, an estimated 169,000 sqm of business parks supply is expected to come online in FY21 and FY22. Of these new supply, c.53,000 sqm or two new business park properties will be added to the Buona Vista and One North cluster. It comprises the Grab Headquarters and Razer Southeast Asia Headquarters which are mostly pre-committed by both firms for its own use. The remaining new supply will come from the Jurong and Tuas clusters which have also received healthy pre-commitment levels from tenants in the clean tech industry, as well as a development for the Surbana Jurong Campus with the majority of space pre-committed.
  • Looking ahead, we expect the city fringe clusters of Buona Vista as well as Harbourfront and Alexandra to continue reporting high occupancy rates. With the continued growth of the technology industry and more FDIs, we believe that landlords will also be able to command higher rental rates due to lack of available space.
  • On the other hand, business park properties in the other clusters like in Jurong (International Business Park and Science Park) may face some pressure due to availability of stock and the ongoing backfilling of previously vacated space.

Six industrial S-REITs with significant exposure to business park assets in Singapore.

Singapore’s warehouses could play a pivotal role in vaccine distribution in ASEAN

Singapore’s strategic positioning within ASEAN and its strong network links could make it a choice location for vaccine distribution in 2021 and beyond.

Singapore’s world-class infrastructure and deep talent pool has led to innovative and efficient processes in every part of the logistics chain.

  • Upon completion of the Next Generation Port 2030, the Singapore port will be the largest integrated facility in the world. The adoption of innovation and automated machinery will boost the efficiency of port operations and data analytics will allow it to better predict and manage traffic congestions. The doubling of capacity of the airport will enable it to manage increased air cargo through Singapore via specialised infrastructure and processes.
  • Private sector participation is another contributing factor to Singapore’s rise as a leading logistics hub. Since the corporatisation of port and airport operators, cargo volumes have multiplied. Competition has encouraged industry players to be more efficient while staying commercially nimble. The government’s partnership with the private sector has helped to attract FDIs and ensured adequate investments into infrastructure are made to support the industry.
  • Singapore’s connectivity, infrastructure and processes, and private sector participation create an integrated ecosystem that allows logistics to thrive.

Acquisition growth to continue into FY21

Industrial S-REITs have been the most active in FY20.

  • REITs’ acquisitions plans were also dampened by the COVID-19 pandemic, with many putting their acquisitions plans on hold and switching to cash conservation mode. Despite being the least impacted segment, many industrial S-REITs canned their growth plans during the height of the outbreak between 2Q- 3Q 2020. However, once the outbreak stabilised and industrial landlords’ operations rebounded, several REITs took the opportunity to resume their acquisition growth plans.
  • To date, industrial S-REITs have completed and announced more than c.S$5.0bn worth of acquisitions. They have been the most active among all the other sub-sectors. We expect them to continue this growth trajectory. Industrial S-REITs have been the busiest in the last quarter of 2020. We expect c.S$2.8bn worth of acquisitions to be concluded before year end.
  • As industrial properties have remained relatively resilient throughout the pandemic, investment interest has been healthy. Moreover, interest rates are expected to remain low in the foreseeable future, which has driven industrial property yields down. This has been especially evident in the data centre and modern logistics segments where yields have compressed significantly.
  • See also recent SGX market update: S-REITs Continued to Pursue Acquisitions.

Acquisitions to continue into FY21.

  • Moving into FY21, we also expect industrial S-REITs to be the most active segment. Ascendas REIT (SGX:A17U) recently conducted a pre-emptive equity fund raising and has set aside S$794m for the acquisitions of a portfolio of data centres in Europe and an office property in Australia. We expect both acquisitions to be completed in FY21.
  • In addition, ESR-REIT (SGX:J91U)’s proposed merger with Sabana REIT (SGX:M1GU)’s S$0.9bn portfolio is also expected to be concluded in FY21, if approved by shareholders.

Industrial S-REITs also have the largest acquisition pipeline from their respective Sponsors.

Singapore Industrial REIT Top Picks:

  • Stay with the winners. The industrial S-REITs are projected to deliver a 5% growth in distributions per unit (DPUs) in FY21, aided by acquisitions while organic growth is expected to remain stable. Given the availability of pipelines coupled with attractive cost of capital, we anticipate more to tap the market in the future.
  • While we anticipate rotational interest out of industrial S-REITs in the near term as market favors a risk-on strategy in the immediate term, we remain buyers on weakness given the strong growth profiles. We believe that upside in demand in the logistics space in support of the vaccine distribution in ASEAN is not priced into share prices as yet.
  • We like
  • See PDF report attached below for complete analysis and also the peer comparison table of industrial S-REITs.

Dale LAI DBS Group Research | Derek TAN DBS Research | https://www.dbsvickers.com/ 2020-12-04
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