S-Reits now cheap with upside potential, worst is over, say Eastspring, OCBC

THE market looks to be pricing in too much downside for retail and office Singapore-listed real-estate investment trusts (S-Reits), said Eastspring Investments' head of client portfolio managers, Adam Matthews, and the company's director of client portfolio managers, Sarah Lien.

The pair wrote in a commentary on Monday: "In our opinion, the sector is oversold as the support measures have provided much-needed relief in the form of dividend deferments, an increase in the leverage ceiling from 45 per cent to 50 per cent, property tax waivers passed on as rental waivers to support tenants' cash flows, and the ability to defer rents until cash flows are able to cover costs."

This is even as S-Reits in general have not fared well in the Covid-19 environment, and are one of the weaker areas of the market on a year-to-date returns basis.

S-Reits remain an attractive investment in a low-rate and modest growth environment - typically the kind of backdrop against which these trusts perform best, Mr Matthews and Ms Lien added.

In contrast with assumptions that weak sentiment, declining retail sales and lower transaction volumes are the new norm, Eastspring is taking a longer-term view and believes there are some opportunities.

In Singapore, Eastspring is focusing on valuations and acquiring high-quality assets at discounted prices.

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While the office segment is still under stress, there will likely continue to be demand for Grade-A office space, not just from financial firms but also from companies in other industries such as e-commerce operators, fintech and social media enterprises, which have been moving into the central business district (CBD), Mr Matthews and Ms Lien wrote.

They added that after the pandemic, larger companies are also likely to diversify their staff across several locations, to take up space in suburban office complexes on top of having a CBD presence in order to ensure business contingency management.

As for the retail segment, malls in Singapore tend to be destinations for families on evenings and weekends, and families are likely to spend more money locally over the next six month because of travel restrictions still in place, said Eastspring.

Singapore's listed property equity space is trading at multi-year lows, offering good value and recurring dividend income for investors patient enough to wait for a recovery - which is largely expected to resume from the third or fourth quarter of this year and into 2021, Mr Matthews and Ms Lien said.

"We believe the worst of the equity drawdown is behind us and that the Singapore real-estate market looks cheap with upside potential, even when factoring in headwinds from Covid-19, rental concessions, extended social distancing and so on," they added.

Furthermore, most Singapore real estate businesses are still paying dividends, even though some have reduced their payouts. Today, the dividend yield on S-Reits averages 4.5 per cent, which Eastspring believes is attractive, relative to the global developed real-estate market with a 3.7 per cent dividend yield and MSCI's flagship global equity index, the MSCI ACWI Index, yielding 2.7 per cent.

OCBC Investment Research likewise believes the worst is over for S-Reits after a difficult first half of this year, and is "overweight" on the sector.

The research team generally believes investors can view the glass as half full for the S-Reit sector over the medium- to long-term horizon, but recognises that there are still near-term uncertainties, it said in a market commentary on Monday. 

OCBC will adopt a "balanced approach" towards investing in S-Reits. It recommends that investors stick with some of the winners, such as those exposed to the sub-sectors of logistics and business parks, as well as S-Reits that have positioned themselves defensively in anticipation of a weaker outlook.

At the same time, investors should complement these winners with Reits in "beaten down" sub-sectors with deep value and supported by strong sponsors.

The research team's top "buy" picks are thus Frasers Logistics and Commercial Trust with a fair value (FV) of S$1.59, Manulife US Reit with a US$0.84 FV, Mapletree North Asia Commercial Trust with a S$1.09 FV, CapitaLand Mall Trust with a S$2.29 FV and ESR-Reit with a S$0.45 FV.

Given the massive stimulus measures unleashed by central banks, interest rates are likely to stay lower for longer. This will continue to drive hunger for good-quality yield instruments such as select Reits, OCBC said.

The hunt for yield has already resulted in the yield compression of the S-Reit sector, with the FTSE Straits Times Reit Index now trading at a blended forward distribution yield of 5.5 per cent, which is 1.4 standard deviations below its 10-year mean of 6.2 per cent. However, the Singapore government 10-year bond yield has likewise seen a sharp decline. This brings the current forward yield spread to 457 basis points, which is 0.7 standard deviations above the 10-year average.

"Hence, on a relative basis, we opine that valuations of S-Reits are undemanding," OCBC wrote.