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Credit Suisse sees S-Reit valuations staying elevated; favours retail Reits
VALUATIONS of Singapore Reits might stay elevated after getting back to their previous highs, with the search for yield likely to continue as central banks keep interest rates low amid a hazy trade and economic outlook, said Credit Suisse in its latest industry research.
"We favour retail Reits, but see profit-taking opportunities in select office, industrial and hospitality Reits where valuations are getting richer even as operating fundamentals are turning more challenging," said Kum Soek Ching, head of South-east Asia research, private banking research, Credit Suisse.
"An increase in gearing limit, as proposed by the regulator, should give wings to S-Reits’ (Singapore real estate investment trusts) acquisitive pursuits," she added.
The Monetary Authority of Singapore (MAS) has invited industry feedback on its proposal to raise leverage limits for S-Reits from the current 45 per cent to 50-55 per cent.
MAS's proposal is timely as acquisitions look set to pick up steam, said Ms Kum.
A higher gearing limit should allow S-Reits to better compete with private equity funds, property funds and foreign Reits, which are likely to have more debt headroom, for acquisitions.
Credit Suisse noted that Reits in many other markets are subject to higher or no gearing limits. Malaysia's gearing limit stands at 50 per cent and Thailand's is at 60 per cent, while countries such as the US, Japan and Australia have no limits.
Credit Suisse expects S-Reits to take advantage of their current higher valuations to raise equity. "With the prospect of greater flexibility in capital allocation, the risk of opportunistic equity fundraising (that is not backed by an acquisition) is likely to diminish."
Having appreciated 18 per cent year to date, S-Reits have a yield spread of 3.4 per cent versus the 10-year Singapore government bond, compared to a historical average of 3.8 per cent, or 4.36 per cent after the global financial crisis.
"While S-Reit valuations look as rich as it can get relative to history, the search for yield in a lower-for-longer interest rate environment could provide more mileage to the outperformance of defensive yield stocks," said Ms Kum.
"Distribution yields from S-Reits do not look unattractive relative to Reits in other developed markets. If the US Federal Reserve (Fed) is perceived to under-deliver against market expectation of a 40 basis point Fed rate cuts by Q4 2019, yield stocks could come under pressure."
Ms Kum added that this scenario would present an opportunity to add to Credit Suisse's preferred Reits.
Retail Reits have shrugged off the headlines of contracting retail sales to be the best performers in the sector so far in 2019, and have reported firm occupancy and positive rent reversion on leases renewed, said Credit Suisse.
The supply surge led by Changi Jewel, Funan and Paya Lebar Quarter has also largely been taken up.
The per capita provision of shopping centre floor space in Singapore remains much lower than that in developed markets such as the US, Australia and Hong Kong, suggesting room for growth in brick-and-mortar retail space.
The shift towards omni-channel retailing also indicates continued relevance of shopping malls in Singapore.
"We expect retail rents in general to stabilise and rise marginally in the next one to two years as soft retail sales and high occupancy cost are mitigated by support from tapering retail space supply," said Credit Suisse.
Credit Suisse's 2019 outlook for other S-Reit sectors - office, industrial and hospitality - look dimmer.
"The two-year-old recovery in office rents may be taking a breather with rent growth slowing in Q2 2019," said Ms Kum.
A weakening Singapore economy and US-China trade war could undermine business expansion and investment plans of one of the most cyclical property sub-sectors.
However, the impact on the office sector is likely to be cushioned by moderate office supply of 0.83 million square feet (sq ft) on average per year between 2019 and 2021.
While Reits with Grade A office exposure are finally reaping benefits of the market recovery with positive rent reversions, they are also trading at one of the lowest yields in the S-Reits sector, noted Credit Suisse.
Weakening exports and manufacturing, particularly due to the US-China trade war, is starting to take a toll on the industrial property market, which has seen a supply surge of 15 million sq ft in 2019, an increase of more than 2.5 times from 2018.
Credit Suisse is "turning more cautious on industrial Reits in light of revenue pressure from the Reits’ domestic portfolios, against loftier valuations (5.0–5.5 per cent yield for the biggest three industrial Reits) after the strong rally".
Against a backdrop of slowing macro environment and a 2.8 per cent room supply growth (versus 0.1 per cent in 2018), Credit Suisse estimates an industry revenue per available room (RevPAR) decline of 6 per cent in 2019 for the hospitality Reits.
"After the completion of several hotel developments/refurbishments in 2019, some of which are deferments from 2018, hotel room supply growth in Singapore is likely to ease to 1.1 per cent per year during 2020–2023," said Ms Kum.
"This should support a long-awaited RevPAR recovery for Singapore hotels in 2020. For 2019, we see earnings risk for hospitality Reits, whose valuations leave little room for disappointment."