Spotlight on reits

Carmen Lee Head of OCBC Investment Research OCBC Bank

Retail sales at suburban malls continued to outperform downtown malls in Singapore as borders remain closed. However, the leasing environment is still soft, which suggests that negative rental reversions are likely to persist as landlords place priority on defending occupancy rates.

Singapore Grade A core Central Business District (CBD) offlce rents have likely bottomed out, but Grade B core CBD offlce rents continue to show weakness. This could be due to a flight to quality, as companies which are doing well have locked in leases at lower rates. Rental reversions were mixed so far, but the level of enquiries is likely to pick up when restrictions are eased.

The industrial/data centre Reits segment continues to do well, especially for Reits with data centre and logistics assets. The accelerated pace of digitalisation and cloud computing trends will continue to beneflt the data centre sector, while modern logistics properties are beneflciaries of structural e-commerce tailwinds. However, supply pressures are still high, with an expected increase in completions this year which is well above the historical average.

About 46 per cent of the supply coming onstream in 2H21 is single-user factory space, and this is typically developed by industrialists for their own use. Industrial Reits are expected to continue to be the most active on the acquisitions front. However, competition for logistics and data centre properties has heated up, thus driving up acquisition costs and compressing yields, and making it relatively more difflcult to flnd highly accretive targets.

The pace of recovery for hospitality Reits remains uneven, although more countries have eased restrictions in 2Q21. We expect the recovery momentum to continue in 2H21 with increasing vaccination rates and further easing of restrictions, although a more meaningful recovery would likely happen in 2022.

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One key downside risk is likely to come from any potential spike in Delta-variant cases, which would then delay re-opening and economic recovery.

We believe there are still selective opportunities within the S-Reit space. Given the progress in global vaccination rates (albeit uneven) and transition to an endemic era, we would look for a basket of reopening/recovery plays, comprising mainly retail and hospitality Reits. They include Ascott Residence Trust (Buy; FV: S$1.21), CapitaLand Integrated Commercial Trust (Buy; FV: S$2.53), Frasers Centrepoint Trust (Buy; FV: S$2.78) and Mapletree North Asia Commercial Trust (Buy; FV: S$1.15).

As the situation remains fluid, we would balance our reopening/recovery basket with Reits with more resilient and defensive income streams that are less susceptible to lockdowns. They include Ascendas Reit (Buy; FV: S$3.83) and Mapletree Industrial Trust.

The generally better-than-expected 2Q 2021 results season supports our view that the outlook is improving after the trough in 2020 which was brought on by pandemic-led lockdowns.

Derek Tan Head of Property Research DBS Group Research

The Covid-19 pandemic has disrupted the way people work, live and consume. It has also accelerated trends such as the faster adoption of e-commerce, driving demand for logistics properties. As companies adopt more fiexible work arrangements, the need for improved connectivity and digital solutions has boosted the demand for data centres, which many see as ''oil'' for the new digital world. We believe investors should invest along the lines of these structural trends.

While the rebound in the economic and real estate metrics in 2021 appears to be on track, the growth momentum appears patchy given the rising risk of the Delta variant which may derail the transition towards a more normalised way of life and work.

While Reits are expected to deliver a robust two-year distribution CAGR of 13 per cent over 2021 to 2023, growth is varied across sectors. Industrials and offices lead the pack, while retail and hospitality will see a more gradual recovery given more cautious sentiment amongst retailers and travel demand.

Our preference within S-Reits is for ''structural growth'' themes of industrial (logistics, data centres) for their ability to deliver certainty of growth and distributions above pre-pandemic levels. We also like the suburban retail structural growth story, which has proven resilient given its exposure to essential trades and the ability to leverage on the work-from-home (WFH) trend. We believe that concerns of office landlords are overdone, as occupiers are unlikely to further tweak their operational layout with most of the space rationalisation unveiled.

In fact, S-Reits have shown to be an attractive infiation hedge. The combination of ample liquidity, supply shortages and rising demand from economic recovery is likely to push infiation rates higher going forward, and we believe that real estate (like S-Reits) will be a beneficiary and an infiation hedge. We believe the market is already positioned for an expected taper from the Fed come 3Q21/4Q21 if infiation continues to rise, and we see a gradual rise in rates in 2H21-2022 supported by positive economic growth, according to our economists.

We do not envision a repeat of the weakness that we saw in 1Q21, and expect it will not be a major hurdle for most S-Reits given (i) increasing confidence of a robust earnings growth of circa18 per cent in FY21; (ii) still attractive spread vs 10-year yields; and (iii) the ability to deliver acquisitions.

A rebound in operational conditions, driven by occupancy and higher rental rates, is generating income growth. In addition, industrial S-Reits are in a virtuous accretive growth cycle as their cost of capital is conducive for them to pursue acquisitions. We believe investors will be compensated for interest rate risk, and can ride the trend of higher capital values.

Foo Tsiang Wei Head of Corporate & Investment Banking, CIMB Bank Singapore

Following the circuit breaker and subsequent Phase 2 heightened alert, tourism-dependent sectors such as retail and hospitality have experienced a very challenging operating climate. However, with the country's high vaccination rates and the government's determined gradual re-opening of the economy we can expect to see signs of recovery in these sectors from early 2022.

S-Reits with exposure to the retail sector should outperform especially those with significant presence in suburban retail as shopper footfall is likely to increase with the return of social activities and interactions. Suburban retail malls have played an important role even as WFH has become more prevalent, supplying nearby residents with daily essentials and groceries.

Logistics and data centre Reits will likely continue to outperform as this sub-segment is driven by the favourable long-term growth of e-commerce and cloud services.

However, we anticipate headwinds to remain for the leisure travel and to a large extent business travel. Hospitality sectors and Orchard Road retailers who depend on tourism may face uncertainty as the return of tourism is dependent on travel corridor arrangements.

S-Reits with exposure to foreign markets that are recovering may present good upside opportunities, such as those in the hospitality sector that benefit from domestic travel and tourism. Globally, the landscape for offices has changed permanently as partial WFH arrangements are likely to be the new normal, affecting demand for commercial office space. However, we believe Prime Grade A offices given their limited supply in some markets are likely to be more resilient.

Many investors fear that rising interest rates will compress cap rates, causing asset value to fall. All things equal, interest rates rise because the economy is doing well and infiation is accelerating. A stronger economy means there is higher demand for real estate, faster rental growth and rising occupancy rates.

Rising infiation means increased costs, including construction and rental costs, which in turn will lead to a rise in property asset value. The same logic explains why property value doesn't increase with falling interest rates.

On the income side of things, a rising interest rate does increase the cost of borrowing for Reits in general but given that most Reits are lowly geared compared to corporates, they are less susceptible to the impact of higher interest costs on their income.

Historical empirical data from other markets show that generalisations about interest rates and Reit performance might have been unfair. Sectors such as logistics and data centres are likely to outpace infiation.

Jolene Seetoh Senior Portfolio Manager, Pictet Wealth Management

Singapore has one of the highest vaccination rates in the world. Efforts are also underway to provide booster shots as the government resolves to treat Covid as endemic and reopen the economy and borders in a calibrated manner. Going forward, the retail and hospitality sectors remain poised to benefit the most as Singapore progresses towards full reopening.

Singapore retail Reits have underperformed this year, as recent spikes in community infection led to tightening of domestic safe measures since May 2021. Restrictions on dine-in, fitness activities and a return to WFH slowed the recovery of the retail sector which was expected to rebound this year.

Despite these challenges, well-managed suburban malls have demonstrated operational resilience due to significant exposure to essential services as part of rental income. The impact of this round of measures is also less severe compared to the 2020 circuit breaker, as more retail activities remain open. Food & beverage outlets were nimble in adapting to delivery and takeaway demands. Fitness and education centres were quick to switch to virtual classes while gyms also introduced outdoor training.

While Covid infections have risen since the easing of measures, a rise in vaccinations and the overall modest severity of infection may see the return of confidence for people to return to malls and offices. Tourism related Reits such as hospitality and downtown malls have also languished due to continued border closure. The hospitality trusts listed in Singapore have assets in major cities around the world, standing to benefit from resumption of global corporate and leisure travel.

Industrial Reits proved to be more resilient and outperformed in 2020, as stayat-home trends accelerated the structural trend of e-commerce and Internet of Things boosted demand for logistics and data centres. Industrial Reits trade at premium valuations and hence could be more vulnerable to rising rates. However, industrial Reits remained committed to acquisitions over the last 18 months, including overseas acquisitions and we believe this would underpin growth.

In the face of a challenging 2021, majority of S-Reits remained focused on their strategy with asset recycling and acquisitions (domestically and overseas) and capital raising. Some also pivoted their investment strategy to enhance the diversity and resiliency of their portfolios, expanding to other segments including logistics and data centres in developed markets as well as longer-lease student accommodation. Such moves position the S-Reit sector for recovery into 2022 and beyond.

S-Reits are currently trading at over 5 per cent forward distribution yield, and an above-average spread over the 10-year bond yield, implying attractive risk-reward for investors.

Natalie Ong Research Analyst, Phillip Securities Research

We prefer the industrial and retail subsectors. Industrials were less affected in FY20, as tenants were less impacted by containment measures. A high proportion of light industrial, factory and warehouse tenants is in the essential services category, while business park tenants were able to work remotely. Although ancillary retail tenants were affected, they typically form a small portion of the tenant base. As such, rebates provided by industrial Reits were relatively smaller.

This resulted in an early share price recovery for the industrials, allowing them to resume accretive asset acquisition, spurring more DPU growth. While tenants may remain prudent with space needs, economic data points to the expansion of the manufacturing sector. Demand continues to come from manufacturing and certain IT verticals, mopping up some of the oncoming factory supply. Biomedical demand should also help to prop up business-park occupancy.

The retail sector will be the immediate beneficiary of further domestic reopening. The resumption of social gatherings and events will increase purchase triggers. As some landlords have signed leases with lower base rents and higher risk sharing, growth in tenant sales should result in higher variable rents for landlords.

We are neutral on the hospitality and office sector. The hospitality sector faces a long road to recovery. While governments have been moving towards reopening international travel, mass leisure travel will likely not return until the later part of 2022. Some hospitality Reits have picked up assets in the long-stay asset class which should help diversify and provide stability for the portfolio, while others are taking the opportunity to undertake asset enhancements in this period of lower demand. These efforts should help accelerate recovery when travel demand returns.

The office sector faces a structural decline. Tenants are still trying to find the optimal working arrangement and space requirement, preferring more fiexibility baked into their lease terms or taking staggered leases on their space. We expect office rents to be soft in the near term.

S-Reits have been active on the transaction front. Portfolio reconstitution should strengthen portfolios while disbursements of divestment gains and contributions from acquisitions could help DPUs recover faster.

Several Reits are exploring redevelopment and AEIs due to lower opportunity costs in this softer leasing environment. These efforts should result in faster later-period DPU growth.

S-Reits under our coverage are expected to deliver 3.9-7.9 per cent FY21e DPU yields. Bloomberg consensus forecasts that 10Y SGS yields will remain below 2 per cent from 2021 to 2022, before crossing the 2 per cent level in 2023. S-Reit DPUs growth should stay in excess of interest-rate growth, providing upside for S-Reits.