The allure of S-REITs

Gravity Defying: Highest Yield-Spreads and Returns Globally.

• S-REITs has risen 28.7% YTD, outperforming even major REITs markets such as US, Australia and Japan etc
  
• We pointed out that S-REITs has one of the highest yield spreads globally in our previous report dated 3 Sep 2012. We took a deeper look at global/regional peers and below are our assumptions and proposed theses why this may be the case:
  
• Why Asian REITs have much higher yield spreads.
  
  • The Asian REITs (S-REITs, J-REITs, and HK-REITs, excluding M-REITs), outperformed the non-Asian REITs (US-REITs, UK-REITs, A-REITs) in terms of yield spreads partly due to higher borrowing costs in the West (consequence of US/European deleveraging) and Australia.
    
  • With the exception of M-REITs, the Asian REITs incur average cost of borrowing (sector average) of ~1.5%-3.1%, much lower than the 5.5%-6.9% expensed by non-Asian REITs.
    
  • We noted that despite risk-free rates being low in the US (1.7%) and UK (1.8%), the actual borrowing costs to companies on the ground are relatively higher, compared to Asia. Western banks have become parsimonious in their lending vis-à-vis the robust loan growth situation amongst Asian banks.
    
  • From our observations, A-REITs and UK-REITs have average cost of borrowings much higher than normalized1cap rates, rendering DPU yields to be trading near cap-rates levels. As a result, yield spreads are much lower in comparison. For US-REITs, the high borrowing costs are partly offset by their higher cap rates, but this is still insufficient to cover the 178-211 bps yield spread lag behind Asian REITs (excluding M-REITs).
    
  • In M-REITs case, both the cost of borrowing and risk free rates are much higher than S-REITs, J-REITs and HK-REITs, resulting in much lower yield spreads.
    
• What gives S-REITs the edge over other Asian REITs.
  
• Higher Capitalization Rates:
  
  • On a sector basis, Singapore has relatively higher normalised2 cap rates (net property income that can be extracted per annum for each S$ dollar invested in investment properties), compared to Hong Kong and Japan.
    
  • For example in HK, cap rates (net basis) for prime office and prime retail buildings on a stabilized basis are around 3%-3.5% and 3.5%-4% respectively. However, in Singapore, cap rates for prime office and prime retail properties are at least 4.0% and 5.0% respectively.
    
  • This enables S-REITs to offer DPU yields of ~6% without trading at price-to-book discount (1.07x PBR). On the other hand, in order to offer DPU yields of ~5%, HK-REITs and J-REITs have to trade at ~0.8x PBR.
    

  Unlikely interest rates hike until end 2014:
  

  • The MAS manages the Sing dollar’s strength by buying or selling currencies to keep its exchange rate against major currencies within a policy band, and by adjusting the band occasionally to steer the exchange rate. This FX-centred monetary policy regime means that Singapore’s short-term interest rates are essentially a function of US short-term interest rates.
    
  • Most economists do not expect any significant interest rates hike until end of 2014, following the US Fed’s intent to keep short-term interest rates near zero till then. If correct, this would imply that the cost of borrowings for S-REITs (some pegged to SIBOR) will stay at current low levels through 2012-2014.
    

  Others reasons:
  

  • The strong SGD, chasing yields climate and lack of investable alternatives in the market are other factors providing price support for S-REITs. Investors are also drawn to the transparency and predictability of S-REIT dividends, particularly in the midst of the external market uncertainty
    

Yields can compress another 70-90 bps (Peak Valuations).

• S-REITs are presently trading at 5.9% FY12 yield and a yield spread of 463 bps. We think there is downside room for another 70-90 bps compression in view of the following two reasons:
  
  • The S-REITs’ average and stabilized long-term yield spread (excluding the GFC period) is around ~370 bps.
    
  • The effective cap rate for S-REITs is around 5.3%. If we take cap rates as the floor for FY12 DPU yield (since overall S-REITs sector trading at P/B of ~1x), there is another 70 bps for yields to be compressed further.
    
• A yield-spread compression of another 70-90 bps equates to an average price appreciation of 13%-19% for the sector.
  

Maintain OVERWEIGHT on S-REITs.

• We conducted a 2QCY12 results round-up and target price update for S-REITs under our coverage. Most S-REITs reported 2QCY12 distributable incomes that were in-line with our forecasts. Moving forward, we expect DPU growth of 1.4%-9.6% per annum over FY11-FY13F (except Suntec REIT which will likely suffer DPU decline due to ongoing refurbishments at Suntec City).
  
• Our top BUYS remain with the more defensible industrial and retail REITs with total returns of 10%-17%. We think their risk-reward proposition still appear favorable to yield-driven investors. Maintain OVERWEIGHT on the overall S-REITs sector.