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S-Reits in the spotlight
THE BUSINESS TIMES’ WEALTH ROUNDTABLE
Real Estate Investment Trusts have staged a strong rebound since the March trough, despite a continuing overhang over specific sectors. Genevieve Cua asks the experts for their near-term views on the asset class
Ms Carmen Lee
Head of OCBC Investment Research
Mr Syed Razif Al-Idid
Head, CIMB Private Banking, Singapore
Mr Derek Tan
Head of Property Research, DBS Bank
Please share with us your outlook for S-Reits broadly with a six to 12-month view, in terms of growth expectations, valuations, distributions and other factors you think relevant.
Carmen: With the global focus on high-growth sectors this year, the Singapore market has generally been neglected since the start of the coronavirus pandemic. With a heavy weightage in financial and real estate companies, these core sectors are now trading below historical averages and in this environment of great uncertainty and further volatility ahead, safe haven companies could be an ideal diversification element. We believe that while risks and uncertainty remain, opportunities are also available as interest rates will stay low for an extended period. This supports demand for good quality yield instruments such as selective S-Reits.
Although the forward distribution yield of S-Reits has compressed, given that the Singapore government 10-year bond yield has also seen a sharp decline, the current forward yield spread is around 457 basis points (bps). This is 0.7 standard deviation above the 10-year average of 416 bps. Therefore, valuations of S-Reits are undemanding and the worst is likely over in terms of earnings after a very challenging 1H20.
Syed: From a country perspective, most sectors in Singapore are projecting an incrementally positive 2H20 outlook with help from the government. The decreasing number of community Covid-19 cases could be an indication that the market is ready to enter into a recovery phase.
Post the latest US FOMC update, short-term rates should stay low for a longer while. S-Reits stand out in the current environment of lower-for-longer interest rates, especially after the MAS's regulatory cap on bank dividends. The sector's valuation is relatively attractive given ~400 basis points yield spread over the 10-year bond yield, versus historical average of ~337 bps. S-Reits' price-to-book is also currently trading below the sector's long-term average.
We expect steady growth in S-Reits to be driven by in-built rental escalations, acquisitions and rental recovery. For some overseas-centric Reits, earnings should be stable given the long-lease expiries and in-built rental escalations.
Derek: S-Reits have been strong performers year-to date but the rebound has been unevenly distributed. Since the low of March 2020, we have seen divergent share price performance across two broad categories. The ''Covid-resilient'' sectors, ie industrial and healthcare S-Reits, have rebounded and share prices have reached new highs, while ''Covid-impacted'' sectors, such as retail, hospitality and office, remain under pressure.
While investors have been rewarded with positive returns in the larger cap industrial S-Reits given their relative earnings resilience against the Covid-19 pandemic, we see the tide turning as the economy recovers. The valuation disparity that we see between these two categories of S-Reits (Covid-resilient vs Covid-impacted) has widened beyond one standard deviation since the outbreak of the pandemic, and we believe this to be unsustainable in the longer term. With most recent positive market datapoints which point to a gradual recovery in the economy, we see a turn in the tide in favour for the Covid-impacted sectors.
Which Reit sectors are you most positive or negative about and why? What risks should investors be most mindful about?
Carmen: The pandemic had a severe impact on S-Reits as earnings and distributions to unitholders came under pressure. For the S-Reits under our coverage, distribution per unit (DPU) fell 27.8 per cent YoY for the 2Q/1H CY20 earnings period. This broad-based blow was felt by all major sub-sectors, with the exception being data centres. Not surprisingly, the worst hit was the hospitality sub-sector, which saw a higher-than-average earnings decline of 61.8 per cent, and this was followed by retail (-45.1 per cent), offi ce (-20.0 per cent) and industrial (-13.5 per cent).
While this has impacted FY20/21F earnings projection, resulting in negative full year growth, we expect a recovery to take place in FY21/22, with a 15.4 per cent improvement in DPU, as more economic activities open up and business volumes pick up.
Our investment methodology takes a balanced approach, that is, we continue to favour sticking with some of the winners such as Reits in logistics and business parks, and we complement these with Reits offering deep value and well supported by strong sponsors.
Within the industrial sub-sector, the outlook for data centres, logistics and business parks is still positive. The digitalisation trend and the need for more data security, cloud solutions, application software, videoconferencing, etc will support demand for data centres. However, challenges for other traditional industrial properties remain.
At the other extreme, the hospitality and retail sub-sectors continue to face challenges, but we believe some glimmers of light are emerging. Hospitality Reits saw the sharpest decline in 1H20 earnings, largely due to low occupancy rates brought on by weak travel demand and strict travel restrictions. As long as travel restrictions remain, the operating environment will remain challenging for the hospitality sector. However, as more countries exit from lockdowns, this sector should recover over the medium to longer term.
Syed: We tend to be sector agnostic as we focus more on bottom-up factors with an emphasis on visible DPU growth potential. However, given the expected recovery in retail, we would informally say our order of preference is retail, industrial, office and hospitality
We are sanguine towards the retail sector from a recovery angle. We expect footfall to gradually increase as consumers spend locally and offi ce crowds slowly return. We noted the suburban malls have already staged a recovery in tenant sales. However, negative rental reversion for the sector is likely in the next few months as rental assistance tapers off. The good thing is that most Reits now have fewer leases left to renew.
We are relatively positive on the Industrial sector, thanks to structural growth drivers like a) office de-centralisation to drive business parks demands; b) e-commerce to drive warehouse demand; c) data centres growth potential; d) stable rents; e) acquisition growth potential (given low funding costs and accretive opportunities).
In the commercial sector, office rents are expected to decline in 2020F due to a weaker macro outlook and scaling back of expansion plans. While there are debates about the longer-term prospects of the office rental market in a post-Covid-19 world, we believe landlords can adapt to offer options to tenants.
The recovery for hospitality will be very gradual until vaccines are made widely available. The nearterm risk is if the Singapore government decides to trim down their hotel bookings for stay-home-notices while borders remain closed, plus the non-renewal of master leases. Although the market has priced in downside risks, the sector may lack re-rating catalysts in the near term.
Finally, sector-wide risks would include a second wave from Covid-19 leading to prolonged economic downturn as well as dilutive equity raisings.
Derek: While we continue to like industrial S-Reits for their earnings resilience, we believe that on a relative basis, by virtue of tighter yields of close to 4.5 per cent, we do not see the outperformance continuing as the market turns more risk-on and higher prospective yields ranging from 5.5 to 7 per cent for the other subsectors.
Given a gradual rebound in economic data, we expect investors to allocate more capital to the subsectors of retail and offi ce, which are seeing emerging green shoots. For retail S-Reits, our weekly trackers and visits to various malls across Singapore reveal a steady return in foot traffi c and if our read-through of the ground is right, we expect strong operational results to come in the third quarter, which is a boost to share price.
We are also seeing interesting developments in the office sector where a potential upcycle in office demand, spurred by the expansion plans of Chinese tech giants, could be underway in a period of low supply completion. While the surrendering of existing office space - as firms adopt more fiexible working practices - will likely be gradual, the immediate demand from these tech giants is a boost to office fundamentals.
With higher gearing limits allowed by the Monetary Authority of Singapore and S-Reits trading in a conducive cost of capital, we see a select group of S-Reits in the retail and industrial space looking for acquisitions to drive growth. We see selective opportunities which could be tapped across various sponsors, especially for properties that have stabilised income profiles. We see acquisitions as a catalyst for further upside in share prices.
Can you please share with us your top three picks of Reits and why you have chosen them?
Carmen: Our top picks are: Frasers Logistics & Commercial Trust (FLT SP) [BUY; FV: S$1.59], Manulife US REIT (MUST SP) [BUY; FV: US$0.84] and CapitaLand Mall Trust (CT SP) [BUY; FV: S$2.39].
Frasers Logistics & Commercial Trust (FLCT) owns a portfolio of prime industrial and logistics assets strategically located within established industrial and logistics precincts across five states in Australia. It also has a presence in the Germany and Netherlands's industrial markets. Following the completion of its merger with Frasers Commercial Trust on April 29, 2020, the combined entity also has commercial and business park assets in Singapore and the UK. One of FLCT's investment merits is its defensive profile given its high occupancy rate, long weighted average lease to expiry with minimal lease expiries in FY20 and FY21.
Manulife US Reit's (MUST) 1H20 results came in within our expectations. Gross revenue and net property income increased by 18.3 per cent YoY and 18.8 per cent YoY to US$98.6 million and US$62.2 million respectively. We like MUST's resilient portfolio, quality tenants, stable income streams from built-in escalations and minimal lease expiry profile which could help MUST ride over the market turmoil.
CapitaLand Mall Trust (CMT) is the largest retail Reit by market capitalisation and assets in Singapore. It offers investors diverse exposure to the suburban and downtown core retail market with its large portfolio of retail malls. Supported by a strong sponsor in CapitaLand Limited, CMT has also been prudent in its capital management, with one of the longest average debt to maturity within the S-Reits sector. Although CMT has been adversely impacted by the global Covid-19 outbreak, we believe it has suffi cient undrawn credit facilities to provide some buffer at least in the near term.
Syed: We do not usually offer ''top picks'' as the selection depends on the suitability to clients' profile and portfolio needs. However, we highlight three Reits that are generally aligned to our previous comments.
• Ascendas Reit is the largest industrial name in the segment. Recent acquisition of the business park portfolio in the US will help contribute to full year income in FY2020F. Its low gearing also should provide it with further M&A potential.
• Mapletree Commercial Trust is uniquely positioned for recovery given its retail assets (Vivocity) and resilience given its commercial assets (MBC I & II). It has a quality asset mix, strong and reputable sponsor, and enjoys low gearing.
• Frasers Centrepoint Trust is the leader in suburban malls and its assets should be able to generate stable income given its focus on less discretionary spending.
Derek: Supported by lower interest rates over an extended period, we expect interest in S-Reits to remain robust over the near and medium term. With yields still attractive at 6.3 per cent in 2021, we expect yields to compress, resulting in continued rerating in share prices. Our picks over the next six months are Keppel Reit, Mapletree Commercial Trust and CapitaLand Mall Trust.