MAS Responses to Consultation Feedback on Strengthening the REITs Market

RESPONSE TO FEEDBACK RECEIVED – CONSULTATION ON ENHANCEMENTS TO THE REGULATORY REGIME GOVERNING REITS AND REIT MANAGERS

 

Performing a reality check

• Expecting rise in interest rates
  
• Focus on fundamentals and growth
  
• Suntec, SGREIT and FCT as top picks
  

Selecting the winners

The S-REITs sector has rallied 7.3% and outperformed STI by 4ppt YTD on US Fed Chair Janet Yellen’s forward guidance that interest rates are likely to stay low “for a considerable time”. However, against this backdrop, we note that the Fed will continue to cut the bond purchases meant to suppress the long-term borrowing costs low, keeping it on track to end the stimulus programme late this year. Even the recent forecasts by the Fed officials point to a possibility that the interest rates may rise faster than previously expected. Given these developments, we now make a conscious effort to select the S-REITs that are likely able to withstand any potential correction better and outperform the rest.

Fundamentals still sound

Our findings show that the fundamentals of S-REITs have generally remained sound, and S-REITs continue to benefit from their past investments and higher secured rentals within their existing portfolios. On a relative basis, the office REIT subsector outlook looks the rosiest, as the uptrend in office rents is likely to be sustained amid strong leasing activity, low vacancy and limited supply in the near term. This is followed by retail REITs, which are poised to reap the returns of their AEIs and the positive operating landscape. For FY15, we note that Suntec REIT and CapitaCommercial Trust are expected to experience one of the fastest increases in DPU, according to Bloomberg consensus forecasts.

Assessing impact from interest rate hike

On the capital management front, S-REITs have again stepped up their efforts to repay/refinance their borrowings ahead of their maturities and over a longer term, as well as hedge their interest rate exposure in anticipation of the potential hike in interest rates. This has resulted in an improvement in gearing, debt duration and hedge ratio. In fact, for a 1ppt growth in interest rate, we estimate the greatest fall in DPU among the S-REITs is contained within 10%, while

several S-REITs such as Starhill Global REIT are likely to be unscathed as a result of fixing 100% of their rates via hedges or fixed-rate notes.

Our sector picks

In view of all this, we retain Suntec REIT [BUY, S$1.85 FV] and Starhill Global REIT [BUY, S$0.90 FV] as our sector picks. CapitaCommercial Trust, our third preferred pick, has performed very well YTD, clocking a 15.9% increase in unit price. At current level, we believe most of the positives have been priced in. As such, we replace CapitaCommercial Trust with Frasers Centrepoint Trust [BUY, S$2.08 FV] as our preferred pick. The latter has a strong financial position, trades at an attractive yield of 6.1% and P/B of 1.06x and is expected to see relatively robust earnings growth over the next year. Retain NEUTRAL on broader S-REITs sector.

The REIT deals

• 1QCY14 results in line for all S-REITs under our coverage.
  
• The US Fed made another USD10b cut to its monthly bond-buying stimulus operations, as expected.
  
• Reiterate UNDERWEIGHT as sector fundamentals are far from exciting, apart from the ‘sell in May and go away’ effect.
  

What’s On Last Week

It was a mixed week for REITs across the region ahead of the Federal Open Market Committee meeting on 29-30 April. As expected, the US Federal Reserve scaled back its QE programme to USD45b, its fourth straight USD10b cut since last Dec 2013, and said more reductions are likely in “measured steps”. On the S-REITs front, the defensive healthcare REITs remained in favour for a second week while the hospitality, industrial and retail REITs turned laggards.

What’s Our View

The S-REITs sector is still down 13.6% YoY and 13.9% since 22 May last year. However, we notice a bottoming-out of sorts since end-March, primarily due to two ladies – Janet (the Dove Yellen) and TINA (There Is No Alternative). There may be a chance of a 1987 melt-up (usually preceding a melt-down), as money is switched from bonds into equities. At this juncture, we refrain from upgrading our sector call as (1) fundamentals have not really improved with YoY forward DPU growth still at modest levels of 3-4%, and (2) the jury is still out on the “sell in May and go away” effect, which has been evident in Asia for the past four years since the GFC (Figure 1). Our economist forecasts Fed funds rate to be raised only after Jun 2015, with SG10Yr yields hitting 2.48% in 2014 and 3.45% in 2015. Should the “risk-on” mode persist for risky assets during May-July, we may revisit our sector call, with an upwards bias, after the 1H14 results.

Price action indicates AREIT may show more resilience compared other S-REITs

US stocks ended lower and treasuries yield inched higher as concerns about QE3 continued to weigh. Investors will closely monitor the FED statement at the outcome of the FOMC meeting next Wednesday night. With triple witching

(expiration of stock index futures, stock index options & stock options) next Friday, US equity indices will be rocky, either way, over the next one week. China and HK markets re-open today.

S-REITs have been one of the worst affected in recent weeks as investors sold down yield names on concerns about QE drawdown. Recall that QE3 was announced in Sept last year. A check back on the price action shows that in line with STI’s

U-turn up, many S-REITs started to further their climb from last November as they benefited from the liquidity inflows.

S-REITs that have declined back to their respective Nov12 lows in the current correction would have effectively reversed and wiped out all the positive price action from the liquidity inflow prior to their decline. Chances are these would be

more resilient going forward compared to those that have yet to decline to their respective Nov12 levels. One SREIT that has fallen back to Nov12 level is AREIT. The stock’s Nov12 low is at $2.28. The stock undershoot that level yesterday to $2.22 but in an indication of bargain hunting, returned back to $2.30 by day’s end. Our analyst upgraded the stock to Buy earlier this week. We expect shares of AREIT to show more resilience going forward compared to other S-REITs. One

example of a S-REIT that has yet to fall to its Nov 12 low level, and thus more vulnerable to weakness, is Cambridge. The stock’s Nov12 month low was around $0.64.

As the dust settles, value emerges

• Rising bond yields generally negative; but S-REITs’ ability to grow distributions a compensating factor
  
• Impact of rising bond yields more “expected than real”
  
• Buy Growth. Picks MCT, MAGIC, FCOT and Cache
  

S-REITs’ ability to grow distributions to compensate for rising bond yields/interest costs a key consideration. We believe that fears of the impact of rising bond yields on S-REITs are an over-reaction at this point as our economists do not expect QE to taper off anytime soon. Over the medium term, a rise in long bond yields is likely to be more gradual than abrupt and S-REITs’ continued ability to grow distributions (estimated at 4.0% y-o-y) is a compensating factor. Thus, we believe that the knee-jerk reaction seen in the S-REITs’ share prices (FSTREI index was down 10% YTD vs STI 5% dip in the past few weeks) is unwarranted.

Impact of rising bond yields “more expected than real”. We have assessed the impact of rising bond yields on our target prices, and the conclusions are: (i) Our analysis indicates that SREIT yield spread of 3.9% based on current share prices have factored long bonds of >2.5%. Prior experience shows that SREITs trade at a 350-390 bps spread when long bonds were above 2%. (ii) Impact from higher interest costs is managable at <3%. Active capital management has resulted in most S-REITs locking in >50% of their debt costs for the next 1 – 2 years. We estimate a 0.5% increase in interest rates to have a <3% impact on distributions, which we see as managable. (iii) NAVs appear safe for now. Worries of cap rate expansion impacting S-REITs’ book values negatively are valid but we do not see it as a concern at this point. Other than for office, we note that higher valuations for S-REIT portfolios (retail, industrial sub-sectors) are underpinned by higher income, which we believe make S-REITs’

NAVs more resilient.

Translation losses a potential risk. The INR, AUD and JPY weakened 2%, 7% and 27% against the S$ respectively since the start of 2013. Thus, S-REITs with exposures in these currencies might see earnings downside and NAV declines from translation losses. From the earnings front, we note that most SREITs have taken hedges to minimize impact.

S-REITs sell-off is over-done, Selective BUYs. We have been advocating a selective stance, and limit our picks to REITs which offer growth that is achievable and visible. We like Magic (BUY, TP S$1.22), MCT (BUY, TP S$1.53), FCOT (BUY TP $1.69) and Cache (BUY, TP S$1.47) for their better than peers’ growth prospects. We have also upgraded A-REIT (BUY, TP S$2.60) and MINT (BUY, TP S$1.63) from HOLD to BUYs on valuation grounds.