REITs – OCBC
Staying defensive in times of uncertainty
What a difference a year makes for the REIT market! Last year, the “REIT as growth” story was birthed by benevolent circumstances. Markets were strong, credit was easy, and the Singapore economy was flying. The property market was booming and REITs became the surrogate for riding the wave.
Circumstances are no longer so accommodating. Share prices of retail/ office S-REITs (Singapore listed REITs) have fallen some 20 to 30% since July 2007, reflecting the breakdown in the credit markets and uncertainty about future growth prospects. Higher long term interest rates have steepened yield curves. We expect interest rate volatility to persist as inflation concerns shape central bank policy and prospects for a US rate hike.
Attractive from a defensive prism. The majority of the S-REITs are trading at steep discounts to net asset values (NAVs). REITs are trading at an average yield of about 7.7%, about 400 bps over the 10-year Singapore government bond rate. This de-rating has given investors an opportunity to take a fresh look at S-REITs as defensive vehicles offering stable cash flows and high yields.
Under-rented office portfolios could drive near-term DPU growth. We are quite positive on the office sector – the prospects of an economic downturn are hedged by limited supply. We expect office rentals to peak by year end and then hold or decline only marginally. This nevertheless implies significant upside for REITs with leases locked in two or three years ago, boosting rental revenues in the coming 1-2 years. For instance, a large portion of Suntec REIT’s office portfolio coming up for renewal is significantly under-rented at S$5-6 psf per month. We have a BUY rating on Suntec with a S$1.71 fair value estimate.
Outlook for retail segment is more uncertain. The outlook for the retail sector is more uncertain, with high economic uncertainty and increasing supply – about 1.2m sq ft of new retail space is coming on-stream over 2008-09 on Orchard Road alone. CB Richard Ellis expects a total 6.9m sq ft of new retail space between 2H08 and 2012, with the bulk (48.0%) coming on-stream in 2009. Marina Bay Shoppes by developer Marina Bay Sands is a major contributor – adding 800,000 sq ft; while ION Orchard adds about 663,000 sq ft. Notable suburban additions include the Big Box development at Jurong Regional Centre and CapitaLand’s Civic, Cultural
and Retail Complex at Vista Xchange.
Conclusion – Overall, we are positive on the office and industrial segments, but neutral on the retail segment. For the residential sector, we see pockets of weakness especially for high-end residential units, but fortunately the bigger listed developers have secured earnings for the next 1-2 years due to strong pre-sold units’ revenues, which will be recognised in 2008-2010. On the REIT space, present good yields for commercial space will continue to support rental income for REITs with exposure to good-class commercial assets.
Link – Performance Table