REITs – OCBC

Perceived risk will drive performance

The growth story is unwinding. Since its establishment in 2002, the SREIT sector has flown on the back of a soaring property market. Portfolio sizes expanded on the back of acquisitions and revaluation gains. Unit prices had also followed suit. The REITs behaved like growth instruments – the focus was on capital appreciation, not yield. This golden era ended quite decidedly this year. The growth story, built on a bull market (rising asset prices) and a cheap market (easy credit), has seen a massive reversal. No thanks to a collapse in unit prices, the sector is now trading at an average 20% trailing yield and a 63% discount to book.

Perceived risk new driver. We believe the sector’s performance will be driven by perceived risk, as measured by the strength of their balance sheets and the quality of their underlying income. Based on reported data, some S$4.4b of debt is due for refinancing in the next nine months until September 2009. Refinancing poses a major challenge for the sector, especially with securitized financing no longer in play and lenders mindful of loan-to-value in a falling market. We feel revaluation losses have a high probability of breaching self-imposed and lender-preferred gearing targets. An equity recapitalization may be necessary. In the midst of such uncertainty, we believe sponsored REITs are likely to show outperformance. On the income side, earnings and distributions are threatened by a rising cost of capital and potential rental declines. Our view is that REITs may benefit from diversification, but will have to watch out for forex-driven revaluation risk.

Recommendations. We have a NEUTRAL rating on the sector. We generally think S-REITs are oversold. As capital appreciation-seekers abandon the sector en masse, we see a new ‘REIT as value’ story emerging. While we expect share price volatility to continue for these institutional favorites, value hunters have an opportunity to selectively pick up some good assets at what we think are really good valuations. We expect substantial declines in capital values and rentals in the office sector – but to a large extent unit prices already reflect these concerns. The impact of global events on the retail and industrial sectors has been slower to register in market consciousness. The industrial sector is quite leveraged as a whole and it may be too early to make the call that risks are fully priced in. Within our coverage universe, we have BUY ratings on Suntec REIT (fair value: S$0.90), CapitaMall Trust (fair value: S$1.94) and LMIR Trust (fair value: S$0.39).