A-REIT – RBS

Proxy to growing industrial rents

We expect strong increases in industrial rents following 41.5% growth in the manufacturing sector in 1H10. All signs suggest tenants in AREIT’s portfolio may look to expand. Shares in AREIT is likely to outperform, in our view, as it is the largest proxy to the industrial property sector. Upgrade to Buy.

Industrial rents look set to rise

We expect growth in industrial rents to accelerate from a mild 1.3% qoq in 2Q10, due to a strong expansion in the manufacturing sector. We now assume spot rental growth of 5-15% in FY11 and 5-10% in FY12 vs a 10% decline in both years previously. Leading indicators suggests that leasing activities at AREIT should improve, as: 1) the tenant retention rate is now close to 80% or similar to pre-crisis levels vs 70% six months ago; 2) tenants’ orderbook increased to nine months vs six months six months ago; and 3) tenants are now operating close to full capacity vs 80-90% six months ago. Enquiries for new space by new players have also increased across all segments for AREIT’s portfolio. Thus, we increase our occupancy rate assumptions by 1-2ppt to 94% for its multi-tenanted buildings (MTB).

A laggard in S-REIT sector

AREIT has underperformed the REIT index by 10pp ytd and the two largest REITs by 10.6pp (CMT) and 17.3pp (CCT). This could be because AREIT’s occupancy rates declined for five consecutive quarters before stabilising at 95.6% (-0.1pp qoq) in June 2010. Industrial property rents tend to lag the manufacturing index by six months, so we believe growth in industrial rents will accelerate given a strong rebound in the manufacturing sector in 1Q10.

Small acquisitions likely in the near term

We believe AREIT is likely to make acquisitions, in line with its plan to increase asset base by S$300m-500m pa. Given it acquired S$238m worth of properties in February, potential acquisitions are likely to be small at S$30m-40m and may involve greenfield projects. Equity raising is hence unlikely given its relatively comfortable gearing of 34%, in our view.

Upgrade to Buy from Hold

We upgrade AREIT to Buy and raise our DCF-based target to S$2.55 (from S$2.00), reflecting the improved outlook we see for the industrial property sector and the lower cost of equity on the back of lower risk free rate. AREIT is the largest industrial REIT in Singapore and should ride the recovery in industrial property sector well, in our view.