SREIT – DB
Exuberance fades, value endures
Attractive valuations; deep discounts to NAV unsustainable medium term
Recent 4Q results show still firm organic rental growth and resilient income, which should shift focus from slowing acquisitions. With a few exceptions, balance sheets are sound and refinancing risk manageable. Following a 30% decline since mid 2007, 3/4 of the REITs are trading below book (which could drive M&A or capital mgt) and we find valuations compelling at an avg FY08 yield of 6.4% (a 400bps spread above the 10-year gov bond), a level not seen since mid-2003.
Acquisitions not the only DPU growth driver; organic growth still firm
While weak equity markets have made the acquisition growth model difficult, organic growth remains intact as reflected by robust DPU growth in the recent quarter. Passing office rents still lag market rents, retail rents continue to firm, and industrial rents are 40% below the peak. Cash flows are defensive with secured leases (min 3 years) and rental deposits (in the event of tenant default).
Balance sheets resilient, refinancing risk manageable
Average gearing for the sector is 30% with a few exceptions such as K-REIT, MLT, and Allco which have above-average gearing. Refinancing costs have not risen substantially despite weak credit markets as a significant widening of spreads has been offset by 30-110bp decline in swap offer rates. Most REITs can sustain more than 15% decline in asset values without breaching the statutory gearing limit.
NAV discounts unsustainable once capital markets stabilise
Equity issuance is likely to be moderate until discounts to NAV narrow, and M&A or value unlocking exercises (REITs have started share buy backs) could help narrow discounts to NAV. Similar to Australia and US, SREITs could be takeover targets if discounts remain. Private equity real estate funds raised US$79bn last year with a US$21.6bn focusing on Asia/ROW. Despite the uncertainty, two S$0.8- 1bn physical market transactions have been completed in the last month.
Valuations attractive – transparency, strong balance sheets a premium
The SREIT index has declined by nearly 30% since June 07, underperforming both the STI and the developers. Valuations are generally attractive at 5.5% FY07 and 6.4% FY08 yield representing a 400bps FY08 spread on the LT bond and 12% average discount to NAV. Amid uncertainty over acquisition growth, we focus on REITs with stronger organic growth profiles and/or discounts to NAV, with transparent structures and sound balance sheets without funding risk. REITs which have mismatch in overseas assets and S$ denominated liabilities may face NAV erosion given the appreciation in the S$.
Top picks for REIT sector – CapitaMall Trust, A-REIT and Suntec REIT
We continue to recommend CMT for its strong retail franchise and its track record in extracting value from assets through asset enhancements (even during SARs), A-REIT for its leverage on the rising business & science park and hi-tech industrial segments and Suntec REIT for a high yield and discounts to NAV. Risks: protracted economic slowdown affecting leasing demand, further deterioration in credit markets and the inability to refinance.
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