Category: REIT
SREITs – ML
All about cost of debt
Downgrading S-REITs
We are increasing our cost of debt assumptions across the S-REIT sector. We reduce our FY09 and FY10 DPU estimates by an average of 5.3% and 6.4% respectively, while our price objectives are cut by an average of 16%. We are now forecasting DPU declines in 2009 for one third of our sector coverage. We reduce our rating on Cambridge Industrial, Ascendas India & First REIT to Underperform.
Increasing borrowing costs
We expect the all in debt costs for REITs to escalate to 5.0% (from 3.6% previously assumed) driven by a combination of factors including: 1) Rising credit spreads; 2) Reluctance of Singapore banks to increase loan book exposure to the property sector and 3) ML view that Asian central banks will need to raise interest rates in response to rising inflationary pressures.
Average debt expiry profiles for S-REITs 2.6yrs
Increasing debt costs are magnified in the context of the S-REIT sector given short debt expiry profiles. We have split out the debt expiry profiles of S-REITs under coverage and estimate that, on average, the weighted average debt expiry profile of the sector is 2.6 years which is half of that developed markets. Earnings will be impacted as early as 2009 as expiring debt is rolled over at higher rates.
Cutting our price objectives by average 16%
In addition to our earnings downgrades we have made changes to our DCF valuations assumptions. On a sector average basis we have increased our cost of debt and risk free rate by over 100bpts to 5.5% and 5.4% respectively. We are reducing our target gearing to 40% which is the level rating agencies begin to downgrade corporate credit ratings for S-REITs.
Sector outlook & valuation
The S-REIT sector is currently trading on FY08E yield of 6.2%, which represents a 280bpts premium to the Singapore 10yr government bond. While valuations are undemanding by historical standards we believe the availability and cost of debt and equity continues to present challenges for the S-REIT sector. We remain cautious on the medium term outlook for the sector which is highly reliant on capital markets for growth and is sensitive to interest rate movements. Our BUY calls continue to support REITs that we believe can deliver on organic growth.
Link – Tables
SREIT – UOBKH
Accumulating bargains after steep correction
Correction was fast and furious. Share prices for Singapore REITs have corrected 6-7% over the past four days. Large cap REITs bear the brunt of selling with steep correction for CapitaCommercial Trust (-7.1%), CapitaMall Trust (-7.5%), Ascendas REIT (-4.1%) and CDL Hospitality REIT (-7.2%). Frasers Centrepoint Trust also fell 6.8%. MacQuarie Meag Prime REIT, KREIT Asia and Parkway Life REIT were relatively unchanged.
On average, the magnitude of correction was in line with the quantum in cut to our target prices. Average distribution yield for Singapore REITs is 5.5%, in line with five-year average. Average yield spread above 10-year government bond at 2.2% is below five-year average of 2.5%.
Lock in the yields. While markets will continue to be shaken by twin fears of inflation and higher interest rates, we are starting to see value in some of the REITs. We have selected a diversified basket of three REITs, Frasers Centrepoint for retail, CapitaCommercial Trust for office and Ascendas REIT for industrial.
Frasers Centrepoint Trust (BUY/S$1.24/Target: S$1.55)
• FCT focuses on suburban retail malls, which provide defensive qualities. Revenue contribution from its largest mall Causeway Point gained 11% yoy to S$14.6m in 2QFY08, benefitting from strong rental reversion and higher turnover rent. 20,816sf of retail space at Causeway Point representing 5% of total net lettable area (NLA) was renewed at 16% above preceding rental rates in 2QFY08.
• Ready pipeline of acquisitions. FCT has a ready pipeline of acquisitions that will double NLA to more than 1.2m sf when fully completed. It has entered into a put and call option agreement with sponsor Frasers Centrepoint Limited for the purchase of Northpoint 2 at between S$139.5m and S$170.5m. Northpoint 2 is expected to obtain temporary occupation permit (TOP) by Aug 08 and is on schedule to be injected into FCT in 1QFY09. We expect YewTee Point and Bedok Mall with net lettable area (NLA) of 80,000sf each to be injected in 3QFY09 and 2QFY11 respectively. We estimate the three new malls to contribute 28.6% of total revenue in FY12.
• FCT provides attractive FY08 distribution yield of 6.24%, a spread of 2.55% over 10-year government bond.
Ascendas REIT (BUY/S$2.34/Target: S$3.00)
• A-REIT has benefitted from strong demand for suburban office space as Business & Science Park accounted for 25% of its portfolio by property value. Renewal rate for Business & Science Park was S$3.76psf pm in 4QFY08, 68.8% higher on a yoy basis.
• A-REIT had a portfolio of 84 properties and total assets of S$4.2b as at Mar 08. The weighted average lease to expiry is 5.9 years. A-REIT has a well-diversified tenant base of over 790 international and local companies.
• A-REIT provides attractive FY08 distribution yield of 6.88%, a spread of 3.19% over 10-year government bond.
CapitaCommercial Trust (BUY/S$2.08/Target: S$2.63)
• CCT owns nine properties in Singapore with 2.3m sf of office space (excluding Wilkie Edge and One George Street), which accounts for 7% of private office stock within Downtown Core. CCT is well positioned to benefit from positive rental reversion as 29.4% of leases for office space are up for renewal in 2008 and 2009.
• Market Street Car Park and Golden Shoe Car Park is strategically located at the heart of Raffles Place and represents latent potential to be redeveloped into Grade A office towers.
• CCT trades at a 25.4% discount to book NAV of S$2.79/share.
Related Post – Table
SREIT – UOBKH
Risk-reward balance tilted negative as yield curve steepens
Long-term interest rates pulling SIBOR higher. Benchmark 10-year Singapore government bond yield has further increased from 3.3% to 3.61% last week. 3-month SIBOR has remained relatively stable to 1.25% but 6-month, 9-month and 12-month SIBOR have trended marginally higher. 3-month SIBOR is likely to have bottomed and a move towards 1.5% by end-2008 is highly likely.
Crude oil prices continue to climb despite signs of demand attrition. Indonesia has cut fuel subsidies and raised petrol prices from Rp4,500/litre to Rp6,000/litre on 24 May. Malaysia has just raised petrol prices by 41% to RM2.70/litre and diesel prices by 63% to RM2.58/litre on 4 Jun. Similar adjustments are also implemented in Bangladesh, India, Sri Lanka and Taiwan. Current high level of energy prices is starting to curb consumption. Airlines have started to cut frequency of flights. Logically, consumers will also start to moderate consumption. However, crude oil prices continue to climb by 4.5% last Thursday and 8.4% last Friday to end the week at historic high US$138.54/barrel despite signs of demand attrition.
Fighting inflation with higher interest rates. Bank Indonesia has raised 1-month interest rate by 25 basis points to 8.5%. The Philippines central bank has similarly raised overnight rate by 25 basis points to 5.25%. The European Central Bank has also signalled possible hike in interest rate in Jul 08 due to mounting inflationary pressures. Interest rates are on the rise on a worldwide basis, except maybe the US, as central banks combat inflation.
Mounting challenges for Singapore REITs from higher interest rates. MAS has raised CPI inflation forecast to 5-6% in 2008, an upward revision from previous 4.5-5.5%. Although downside risk has heightened in recent months, MAS has maintained Singapore GDP growth forecast of 4-6%. The strong S$ is expected to provides some cushion again inflation.
The steepened yield curve pose challenges for Singapore REITs as it hamper efforts to secure longer-term funding. Investors will be concerned that REITs may face difficulties refinancing short-term borrowings and to grow via acquisitions. We have further adjusted our target prices for Singapore REITs to factor in a higher risk-free rate of 3% vs previous 2.50%. We are using required rate of return of 8.5% for our dividend discount models.
We have cut our target prices for Singapore REITs by another 4% to 6%. We have also downgraded our recommendation for CapitaMall to HOLD as the stock provides upside of only 2.1%.
Ascendas REIT (BUY/S$2.44/Target: S$3.00)
• A-REIT has benefitted from strong demand for suburban office space as Business & Science Park accounted for 25% of its portfolio by property value. Renewal rate for Business & Science Park was S$3.76psf pm in 4QFY08, 68.8% higher on a yoy basis.
• A-REIT had a portfolio of 84 properties and total assets of S$4.2b as at Mar 08. The weighted average lease to expiry is 5.9 years. A-REIT has a well-diversified tenant base of over 790 international and local companies.
Parkway Life REIT (BUY/S$1.21/Target: S$1.52)
• The minimum rent payable by each hospital is set at Consumer Price Index + 1% above rent payable in the preceding year. Assuming CPI is 5.5% in 2007, the minimum rental increase for Gleneagles, Mount Elizabeth and East Shore hospitals is 6.5%.
• Parkway Life REIT will be acquiring two nursing homes Yokohama City and Ibaraki City in Japan for S$34.9m. Nursing home operator ZECS Community Co Ltd will lease back the properties for 15 years with option to extend for an additional five years. The properties provide net operating income yield 6.1% and 6.7% respectively and rental income is indexlinked to inflation with rent reviews every five years.
SREIT – UOBKH
Relative attractiveness of REITs affected by spike in bond yield
Long-term government bond yield on the rise. Benchmark 10-year Singapore government bond yield has spiked up from 2.4% to 3.4% last week. We believe this is a knee jerk reaction to the near collapse of the bond market in Vietnam. The worldwide trend of higher commodity prices and sustained inflation is likely to have contributed as well. The increase in Singapore’s CPI from 6.7% in Mar 08 to 7.5% in Apr 08 has reignited fear of runaway inflation.
Short-term interest rates remain unchanged. Fortunately, three-month SIBOR has remained stable at 1.1875%, suggesting ample liquidity in the banking system. This means that Singapore REITs are not affected as most bank borrowings are priced off SIBOR. Singapore REITs has been able to secure loan facilities and issue medium term notes with tenure of two to three years at competitive interest rates. Longer term funding has so far been secured mainly through issue of convertible bonds. The steepened yield curve does pose some challenges as it hampers efforts to secure longer term funding.
Big is beautiful. We remain positive on Singapore REITs with economies of scale, such as CapitaCommercial Trust (office), CapitaMall Trust (retail) and Ascendas REIT (industrial). On average, Singapore REITs provides distribution yield of 5.5%, which is fairly attractive. The strong S$ provides some cushion again inflation. Also, Singapore is drastically different compared to Vietnam, an emerging economy that has just opened itself to foreign investment. Vietnam’s bond and equity markets are relatively small and undeveloped compared to other countries in the region.
We have, however, adjusted our target prices for Singapore REITs to factor in a higher risk-free rate of 2.50% vs previous 2.35%. We will make further adjustments depending on how the financial system responds to higher commodity prices and inflation. Our preferred BUYs for Singapore REITs are Ascendas REIT, CapitaCommercial Trust and Suntec REIT.
Link – Yield Table
SREITs – DB
Returning to a virtuous cycle
Re-rating based on organic growth, acquisitions and availability of funding
We expect the re-rating of Singapore REITs to continue, based on: 1) firm trading performance, 2) the availability of funding allowing the return of acquisitions to the sector, and 3) steady physical asset markets. We see a return to a virtuous cycle for the larger REITs, which have demonstrated their ability to raise capital and acquire assets. The valuations for CMT and Suntec REIT are attractive (as CMT has been weak since the Atrium acquisition, and Suntec has lagged its peers).
Better-than-expected 1Q08 earnings; reversion cycle supportive
The REITs delivered 1Q08 DPU growth ahead of expectations (avg 19.1% YoY), based on reversionary rental growth and full occupancy rates. The near-term outlook remains positive, as office and industrial passing rents still trail market rents and retail rents are firming up due to asset enhancements and the entry of new retailers.
Raising capital, a pick-up in acquisitions; majors gaining market share
Singapore REITs have announced S$2.9bn of acquisitions YTD as activity from opportunistic funds have slowed. AREIT’s acquisitions have gained momentum at the expense of competitors who face funding constraints. The REITs have been able to raise funds for acquisitions and debt refinancing, and the completion of KREIT’s S$552m rights issue helps to address concerns over refinancing. Funding costs have been largely contained, as declining swap rates offset a rise in spreads.
Physical market steady as REITs and core funds stepped up to acquire
More than 2/3 of the REITs are trading below book NAV. Recent investment transactions, such as 71 Robinson (S$3,125psf), One George Street (S$2,600psf), and the Serangoon White Site (est. breakeven S$2,000psf), suggest firm asset pricing due to REITs and core funds being more active. Book NAVs for commercial REITs are typically conservative and are at discounts to recent open market transactions.
Focus on large, quality names; smaller REITs likely takeout plays
Yield spreads remain well above average at yields of 5.0% for CY07 and 6.1% for CY08E, representing a 342bps spread over the 10-year gov’t bond and avg. 9.1% discount to book NAV. Inflows into real estate funds have improved in recent weeks, supporting global REIT markets. We prefer the larger REITs which are able to deliver organic growth, mobilize funding, and potentially gain market share. We view the smaller REITs as likely takeover targets if deep NAV discounts persist.
Top picks for REIT sector: CMT, Suntec REIT and AREIT
CMT is attractive after the pullback following the CB issue for the Atrium deal. We believe that CMT has the right platform to extract value and synergies from that asset. Suntec REIT continues to benefit from robust demand in both the office and retail segments. We also like AREIT for its leverage on the rising business park segment. Risks include any protracted economic slowdown affecting demand, further deterioration in credit markets, and inability to refinance.