Singapore REITs have suffered the brunt of the stock market correction. Our index of 14 REITs corrected 16.9% in 1H08 and 27.2% in 3Q08 and underperformed FSSTI, which corrected 14.9% in 1H08 and 19.9% in 3Q08. The sector was affected by tightening credit markets and a steepening yield curve, which have resulted in higher costs of borrowings. Indiscriminate selling of REITs linked to embattled Macquarie Group and American International Group has also brought valuations to depressed levels.

Yield spread at historic high. Singapore REITs provide a distribution yield of 8.8%, which is almost two standard deviations above the mean of 6.0%. Yield spread between Singapore REITs and 10-year government bond has reached a historic high of 5.5%. On a weighted average basis, Singapore REITs are trading at a steep 39% discount to NAV. Market pessimism presents an exceptional value proposition.

Threat from inflation has eased. The fear of runaway inflation has subsided with the correction in the prices of crude oil and other commodities. Yield for 10-year government bond therefore corrected from a high of 3.9% in Jun 08 to 2.9% in mid-Sep 08. Although bond yield has rebounded to 3.2% recently, the upward momentum is not sustainable as further increases in commodity prices are expected to be mild.

REITs provide stable, visible and recurrent income. In addition, catalysts for recovery include the following: a) normalisation in credit markets as systemic risks subside over time, and b) eventual reflation in Asian economies due to fiscal stimuli and growth in domestic consumption. Ascendas REIT and Frasers Centrepoint Trust are well positioned to weather the credit crisis due to their A-rated credit standing and support from government-linked sponsors Ascendas and Fraser & Neave. Suntec REIT has refinanced its short-term borrowings and does not have a significant need for refinancing till Dec 09.

We have upgraded Singapore REITs from MARKET WEIGHT to OVERWEIGHT due to the overwhelmingly attractive yield spread. Our top picks are Ascendas REIT, CapitaCommercial Trust, Frasers Centrepoint Trust and Suntec REIT.

Retail REITs: Resilient and defensive. Retail REITs benefit from healthy job creation and population growth in Singapore. We like suburban malls that cater to non-discretionary consumer spending by the population base in the HDB heartland and are conveniently located next to MRT stations. They provide defensive shelter from the increase in supply at Orchard Road and stability in occupancy. BUY Frasers Centrepoint Trust for its focus on suburban malls and ready pipeline of acquisitions. BUY Suntec REIT for improved connectivity to Suntec City when the new Circle Line is ready in 2010 and positive rental reversion for Suntec Office Towers.

Industrial REITs: Bucking the trend. Industrial REITs provide defensive strength with a weighted average lease term to expiry of 5.5 years for Ascendas REIT and 6.4 years for Cambridge Industrial Trust. They are protected by security deposits for long-term leases amounting to 10.4 months for Ascendas REIT and 17.0 months for Cambridge Industrial Trust. Industrial REITs also benefit from positive rental reversion as many companies are relocating non client-facing backroom, data centre and other support functions to suburban locations. BUY Ascendas REIT as business & science parks and hi-tech industrial buildings account for 52% of its portfolio.

Office REITs: Correction underway. Office rentals peaked in 2Q08 as the volume of leasing transactions driven by expansion fell. Negative dynamics will prevail with impending supply coming on stream starting 2010, which is substantially concentrated within the CBD. This is exacerbated by the government's intention to decentralise commercial activities and additional supply coming from transitional office sites. However, our stress test indicates that current share prices for office REITs have imputed a drastic 70% collapse in rentals to below S$5psf pm for Grade A office space in Raffles Place. While we agree that the outlook for office REITs is lacklustre, we find CapitaCommercial Trust oversold.