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Credit Suisse: S-REITs In Strong Position To Ride Out Volatility
Aspire, Hot Picks | 15 January 2015
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By: Lim Si Jie
Articles (169) Profile

Singapore’s REITs are in a stronger position to ride through the expected rising interest rate environment. 2015 will be another tricky year with interest rates likely to remain relatively volatile.

Given the relatively volatile macro and interest rate environment, we believe REITs with a strong balance sheet, and a defensive or high visibility earnings should perform better in 2015.

Fixed Debt Lowers Risk From Gradual Rise In Interest Rate
Credit Suisse (CS) Economist Michael Wan “expects interest rates to rise on a moderate basis, with the SG government 10-year bond yields likely to rise towards 3 percent”. CS believes that this rise in bond yields will likely be “in a gradual manner”.

Most of the S-REITs have a flatter debt expiry profile and a higher percentage of its debt fixed. This debt characteristic will give management more time and room to manoeuvre revenue growth while offsetting higher interest rate costs at the same time maintaining distribution yields.

CS believes that this will help S-REITs reduce the impact of higher interest rates on their profitability.

Source: The Bloomberg Professional Service

In the above charts, CS notes that in the past two years, S-REITs’ performance was about 90 percent correlated with Singapore 10 year government bond yields (left chart). Spread between the two asset classes (REITs and Government bond yields) are now broadly similar to the levels CS saw pre-tapering in mid-2013 (right chart).

Regulatory Change In 2015
MAS released a consultation paper (October 2014) to improve the corporate governance and transparency on S-REITs. This includes proposals to have a standardised gearing limit of 45 percent, increasing development limit, and other potential regulatory changes. Although no decision has been made yet at this juncture, it will be important for REIT investors to keep the potential change in the back of their minds.

Sub-Sector Performance Outlook
Office REITs
Office REITs have risen some 15 percent in the past 52 weeks on expectations of rents increasing on the back of office demand recovery. The rise could also be due to the relatively short supply of office space. However, CS remarks that more in-depth analysis showed that office demand has actually been “disappointing, with 9M14 net demand only hitting 43% percent of FY13 data” (bottom left chart).

Source: URA (left chart), JLL, CBRE, Credit Suisse estimates (right chart)

Amidst the volatile macro backdrop globally, office demand is likely to be constrained. Given the oncoming supply in 2016 and 2017 (top right chart), we believe that we are unlikely looking at a “severe supply crunch” situation. Because of this, CS has largely taken a “profit-taking” approach to Office REITs.

Retail REITs
CS believes that the retail sales outlook for Singapore will likely be “more positive” in 2015 than in 2014. They make the following points for their fairly bullish case:

  • Expectations of higher GDP growth
  • Wage growth (underpinned by low unemployment and labour restructuring policies)
  • Prospects of a more “positive” economic outlook in 2015
  • Celebrations of Singapore’s 50th year of independence could pull in more tourism and domestic retail receipts
  • Potential elections in 4Q15 might mean some goodies from the government that could spur retail spending

However, the retail industry is still reeling from a significantly soft 2014. Because of this, CS believes that the sector may see retail tenants consolidating. On top of that, with rising cost pressures and labour restrictions, we believe that tenants will be “focusing more on” the sales productivity per square foot.

Source: JLL (left chart), URA, CBRE, Credit Suisse research (right chart)

CS notes that suburban mall recents continue to remain resilient in 2014 (top left chart). This is in contrast with malls located in the primary and secondary areas of Singapore. CS also points out that malls in the downtown area appears to have the weakest fundamentals (top right chart). This is owing to a jump in supply (+32.5 percent) that could offset any potential demand growth.

Hospitality REITs
Near-term room rates will be under pressure with upcoming new supply. Competition and a shorter visibility on corporate demand amidst global volatilities have impacted the rest of the sub-segments, which have seen relatively lacklustre REVPARs (Revenue Per Available Room) so far in 2014, with the exception of the luxury segment.

Hotel operators who focus more on room rates (luxury segment) than occupancies (upscale and mid-tier types) will be the recommended picks.

Top REIT Picks For 2015
There are a number of quality defensive S-REIT stocks that CS prefers, i.e. those with stronger market positioning. The increasingly challenging macro outlook may result in “competitive pressures”, where dominant players should be able to withstand better compared to its peers.

CapitaMall Trust (CMLT.SI, OUTPERFORM, TP S$2.40):
CMT’s has one of the most resilient portfolios with 75 percent of the malls within its portfolio catering to “necessity shopping”. CS notes that CMT’s occupancy was sustained at 98 percent during SARS and sub prime crises.

With CMT’s network of malls as well as its more productive portfolio, we believe tenants will remain sticky to better-managed malls like those managed by CMT. However, CS notes that a key pushback from investors will be the concern on slowing retail sales and its potential impact on rent growth.

Mapletree Industrial Trust (MAPI.SI, OUTPERFORM, TP S$1.68):
CS recommends MAPI as its “risk reward is relatively attractive at 6.9 percent FY15E yield” on top of expectations of positive DPU (dividend per unit) growth coming from:

  1. Rent reversions coming from its expiry of the rental caps applicable for the JTC Tranche 2 acquisitions (expire on 23 August 2015); and
  2. Asset enhancement and build-to-suit project conversions, which will result in higher rentals upon completion.
Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

CapitaLand Mall Trust  2.610 -0.01 -0.38%   
Business: Co owns and invests in quality income-producing assets which are used, or predominantly used, for retail purposes primarily in Singapore.

Insight: Apr-19, 1Q19 gross revenue and NPI rose 10% and 11... Read More
Mapletree Industrial Trust  2.450 +0.01 +0.41%   
Business: A REIT that invest in industrial ppties in S'pore.

Insight: Apr-19, FY19 revenue rose 3.5% mainly due to reven... Read More


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