Reits still offer refuge from global volatility

Singapore

BROKERAGES are flagging more volatility for the Singapore real estate investment trust (S-Reit) sector, but they are also calling a "buy" on it.

This is mostly because brokerages believe S-Reits still make a good defensive yield play amid growing global uncertainty and slowing growth in major economies. Yield plays gain traction as a safe haven in an unsafe world.

S-Reits have also outperformed the broader market and their defensive counterparts, such as telecommunications and utilities. Year-to-date, the FTSE ST Reit Index has returned 7.2 per cent (assuming dividends are reinvested), versus 3.3 per cent for the Straits Times index, 1.7 per cent for the telco index, and a negative 11.2 per cent for the utilities index.

The industry is not expecting a calm 2017. Consensus appears unanimous that next year will continue to be rocky for Reits.

Already in 2016, the sector was badly shaken in January by a steep sell-off in the Chinese stock market, which triggered a rout in global equity markets. Markets recovered in June, buoyed by Brexit because people equated more global uncertainty to "lower for longer" interest rates - a plus point for Reits. Then Donald Trump won the US presidential elections in November, and Reit prices plunged back below pre-Brexit levels as the market worried that inflation may rise faster than expected on Mr Trump's fiscal policies.

The final curtain call for the S-Reit sector happened on Dec 14 when, after a whole year, the Fed finally raised the federal fund rate by 25 basis points to 0.5-0.75 per cent. In the following two weeks, the Reit index lost 3.6 per cent in anticipation of more aggressive increases in the Fed interest rates in 2017.

Global volatility is unlikely to ease in the new year. Italian Prime Minister Matteo Renzi this month said he will resign after conceding defeat in a constitutional referendum, raising fear that this could put the Five Party Movement - a party that has for years advocated a referendum on Italy's eurozone membership status - in power. This points to more uncertainty in the eurozone.

This could be good news for Reits, as the Fed might have to reconsider its move to normalise interest rates if it sees an unstable eurozone upsetting the financial markets.

UOB Kay Hian analyst Vikrant Pandey is one who belongs to the camp which believes continued uncertainty in Europe, along with depressed growth prospects in Asian markets like Japan and China, will give the Fed pause to speed up interest rate increases in 2017.

Within Singapore, besides weak economic growth - private-sector economists have trimmed GDP growth forecast for next year to 1.5 per cent - there is also a huge impending oversupply of space to contend with.

Commercial rents for some Reits are already falling. In a Dec 1 report, credit rating agency Moody's said: "In line with the subdued outlook for the country, we expect overall occupancy and rental rates for all property segments, apart from healthcare, to be under pressure because of abundant supply and soft demand. We see most stress in the office and industrial property segments."

Most analysts say that S-Reits have long braced themselves for rate increases by extending their debt maturities and increasing the proportion of their fixed rate debt. Reit managers have also adopted hedging strategies to manage their foreign exchange and interest rate risks.

Religare's calculations indicate that including the 0.25 per cent rate hike in December, followed by two rate hikes of 0.5 per cent each in 2017, distribution per unit (DPU) across Reits could dip by an average 2.2 per cent.

Among the Reits covered by OCBC Investment Research, those with the smallest share of their debt fixed or hedged as at end-September are CapitaLand Retail China Trust (52.8 per cent), Frasers Centrepoint Trust (59 per cent) and Suntec Reit (60 per cent).

Analyst Andy Wong cautioned that S-Reits will not be totally immune to a higher interest rate environment, as they will still face higher hedging costs when they roll over their interest rate swap contracts. He noted that following the recent jump in interest rates, hedging costs have also increased.

The new year is also expected to see the Singapore currency falling against the US dollar, which could deter overseas investors, encourage those already here to pull out and hurt the S-Reit market.

Religare analyst Pang Ti Wee said: "If investors take a bullish view of the US dollar in 2017, fund outflows from Singapore could accelerate and lead to a sell-off in S-Reits and the commercial property market."

But there are exceptions, like Manulife US Reit which owns office buildings in three American cities. It is likely to gain from the situation.

RHB analyst Vijay Natarajan said: "Being the only listed Reit in Asia offering 100 per cent exposure to US office properties and USD exposure, we believe Manulife US Reit offers the best proxy to a growing US economy."

He has a "buy" rating on the stock with a target price of US$0.96. The stock last closed at US$0.83.

Mr Natarajan also believes that the impact of a rate hike would be less painful for Manulife US Reit, as the hike would coincide with a pick-up in US office demand and a stronger USD which would benefit its unitholders.

There are also potential listings and merger and acquisition (M&A) activity to watch for in 2017. Two Australian property developers are reportedly eyeing Singapore listings.

Australia-listed real estate investment manager Cromwell Property Group is looking to list some European office buildings worth possibly US$1 billion.

Sydney-based Crown Group is the other company considering a Singapore listing in the next one to two years. It has around A$4.8 billion (S$5.1 billion) worth of projects in the pipeline as at January this year.

On the M&A side, 2016 has seen some firsts for the Reit and business trust sectors, such as the internalisation of the manager of Croesus Retail Trust and a reverse takeover of Saizen Reit - an unprecedented corporate move in this industry.

In addition, there was a manager ownership changeover at IReit Global. The new owner is Tikehau Investment Management Asia Pacific, a pan-European investment group. The CEO and chief investment officer at IReit Global quit after the changeover of ownership.

Something also seems to be underway at Cambridge Industrial Trust, whose previous CEO Philip Levinson had supposedly tried very hard to either internalise or sell Cambridge Industrial Trust, but without success.

Mr Levinson resigned in November this year, and was replaced by acting CEO Shane Hagan. Industry people are saying that the manager does not appear to be in a very strong position, making it a susceptible target for acquisition.

When contacted, Mr Levinson said: "I left when I thought that I couldn't add any more value." Asked on the progress with the buying interest in an 80 per cent stake in the manager, he replied: "I am sure there will be an outcome."

He added that the move towards consolidation and M&A among S-Reits is propelled by the need for size. "That is a result of the desire and trend towards more passive investments, where the passive investor will look more favourably on larger Reits."

Others in the market note that industrial Reits are looking like attractive takeover targets, with many smaller ones trading significantly below their book value. They say that there are predatory offshore real estate funds eyeing them as a shortcut to acquiring good property portfolios on the cheap.