REITs – Kim Eng

S-REITs update

Prices of S-REITs have declined over the past one month since the release of the quarter ended June results, with CDL Hospitality (CDLHT) and Ascott Residence declining as much as 18-22%. While recent valuations reflect expectations of slower acquisitions and rental growth, we observed two positive developments: 1) refinancing issues have been cleared up and 2) yields spread have widened. But despite reduced gearing, managers will focus on organic growth in the foreseeable future and de-emphasizing acquisitions.

Hospitality and office/retail REIT had a good quarter but the going will get tough
High hotel occupancy rates over the past year and sustained retail/office rental growth benefitted CDLHT and Suntec Reit (SUN) in the period ended Jun 08, evident from their strong YoY DPU growth of 44% and 30%, respectively. SUN and FCT delivered good QoQ growth of 8.4% and 7.4%. Annualized DPUs of S-REITs were generally in line with consensus FY08 estimates. Unfortunately, most sounded rather cautious on the outlook which spooked the market.

Organic growth seems to be the only saving grace
Management teams have generally highlighted the lack of yield accretive acquisitions. Even if there are, REITs face difficulty tapping the capital market in this environment. We focus on REITs with organic growth potential. The organic growth of CCT (Rating: Buy) will be driven by rental reversions with about 41% of the office leases expiring between 2009 and 2010. The weighted average rental of leases expiring in 2009 and 2010 for 6 Battery Road is approximately 45% below the current micro-market rentals. Office rentals are likely to remain resilient until a substantial supply of prime office space come onstream in 2010, allowing CCT’s rentals to catch up with the market.

Refinancing woes resolved
The debt profile of S-REITs has generally improved, with no immediate need to tap the capital market for fund raising. It is notable that SUN has refinanced its remaining bridge loans with S$400m unsecured club loan extended by several banks at highly competitive spreads, a sign of a hopeful credit situation for REITs with strong credit standing. K-Reit has also seen an improvement in gearing ratio from over 54% down to 28% after its rights issue. REITs with lowest gearing include CDREIT, FCT and Plife Reit.

Fear of potential write-down of capital values overplayed
While fears of a potential write-down of capital values are valid given the steep discounts to NAV, a write-down will not affect cash distribution as least in the medium term as rentals have been locked in leases. We do not see a write-down coming for the retail REITs CMT and FCT due to the AEIs. In the office space, recent transactions done at average prices of $2400 psf in 1H08 reflect still tight office supply. REITs with low gearing are also preferred as they would be far from hitting the maximum allowable gearing limit in the event of a write-down. Some commendable names are CDLHT, PLife Reit and FCT.

Lower bond yield widens spread
Weekly average 10-yr SGS bond yield decreased from a high of 3.9% mid-Jun to 3.2% end-Aug. 12-mth SIBOR decreased from a high of 2% to 1.75% over the same period. 5-yr SGD swap also declined 100bp to 2.9%. The projected yield of 6.3% for CCT (Buy) offers an attractive 310bp spread over the 10-yr bond yield, while CDLHT (unrated) also offers an attractive yield spread with 9.7% projected yield.

Link – Table