New REIT in the making – Another property stock enters the spotlight. A news report today revealed that private developer Far East Organization (FEO) is said to be planning to raise at least $500m through the listing of its hotel and serviced residence assets in a REIT as early as next year. What is interesting is that one of the assets to be spun off into the REIT is Orchard Parade Hotel, owned by FEO’s listed entity, Orchard Parade Holdings (OPH). In fact, in a statement last evening, OPH confirmed that it is in preliminary discussion with FEO over the injection of assets into the REIT. Other assets owned by OPH include Albert Court Village Hotel near the upcoming Rochor MRT Station, and Central Square Village Residences along Havelock Road. Both would fit the REIT’s profile well. A possible scenario is the privatisation of OPH before the formation of the REIT next year. This is because the hospitality assets are worth an estimated $500m collectively, and that already makes up 90% of OPH’s current market capitalisation. We had earlier identified Orchard Parade as a potential privatisation target on the premise that the stock trades at a large discount to book and has substantial shareholders with deep pockets.

Sustainable growth

• High yield spreads and a strong S$ continue to attract investors to S-REITs

• MCT, FCT, MLT expected to deliver strong earnings growth in coming quarters

• Relative value in smaller cap REITs like Cache and FCOT

S-REITs outperformed benchmarks but still offer an attractive 350 bps over long bonds. Having outperformed the FSSTI and developers by 3% and 13% respectively YTD, S-REITs currently offer a weighted average yield of 5.9%, which remains an attractive c350bps over the long-term government bond. The current high yield spread and a strong S$ will continue to sustain investor interests in S-REITs.

Looking for “positive earnings surprises”. As we approach the upcoming second reporting quarter for 2011, we believe that earnings growth sustainability will remain a key focus. We remain positive that Hospitality S-REITs should continue to deliver strong results, judging by latest statistics posted by the Singapore Tourism Board, but we believe that street has already priced in strong growth expectations. Retail REITs are expected to see positive rental reversions going forward supported by the current positive consumer sentiment. FCT (BUY, TP S$1.73) is expected to deliver a good set of numbers in the coming quarters, as reconstruction works at Causeway Point have passed the most crucial stage, with committed occupancy at over 99%. In addition, the impending purchase of Bedok mall will act as a re-rating catalyst for the stock. MCT (BUY, TP S$1.05) should also see strong reversionary rental growth of c10% in the coming quarters, coming off from a first renewal cycle at its Vivo city retail mall.

Acquisition-driven growth. S-REITs have collectively acquired cS$1.9bn of assets YTD, which should start contributing to earnings in the coming quarters. After two months of relatively flattish DPU, we believe MLT (BUY, TP S$1.07) is poised to deliver a strong uptick in earnings momentum, boosted by recently completed acquisitions.

Value proposition in smaller cap S-REITs. We see relative value amongst certain smaller cap S-REITs. Cache ( BUY , TP S$1.11), which currently offers a yield of over 8.0%, is attractive, backed by transparent earnings structure and armed with a low leverage of 26%, has the headroom to acquire further. FCOT (BUY, TP S$1.05), at a P/BV of 0.6x, is unjustified in our view, given the yield enhancing steps taken by management and plans to re-finance its expiring loans should result in future interest savings.

Reit players see growth via acquisitions in region

This will be driven by market liquidity and reduced capital cost

ASIAN real estate investment trusts (Reits) are poised to grow through acquisitions, industry players said at a forum yesterday.

The industry players, who were speaking at a panel discussion at the annual Real Estate Investment World Asia conference, said the expected growth will be driven by the lower cost of capital and ample liquidity in the market.

‘The cost of capital is getting back to an area where it makes it more attractive for Reits to acquire assets,’ said Jason Kern, head of real estate advisory at Hongkong and Shanghai Banking Corporation (HSBC).

Mr Kern noted that the Reit market in Asia has picked up in the past year, with six new Reit listings over 12 months. According to data from HSBC, there are currently 98 Reits with a total market capitalisation of US$97 billion listed in Asia.

Nicholas McGrath, chief executive of the manager of Singapore-listed AIMS AMP Capital Industrial Reit, agreed that the cost of capital had fallen and added that there is a lot of liquidity in the market.

The panellists also said that they expect more Reits to launch their initial public offerings (IPOs) in the coming months.

Kevin Xayaraj, chief executive of Singapore’s first Syariah-compliant Reit, Sabana Reit, expects more similar Reits to be floated this year. Sabana Reit was listed on the Singapore Exchange in November 2010.

‘With the success of the IPO, I think there will be a lot of Syariah-compliant Reits coming to Singapore and the rest of Asia,’ he said.

But Peter Churchouse, managing director of Portwood Capital, noted that there are still some major obstacles that prevent the Reit industry in Asia from expanding as quickly as it would otherwise have.

There is still a sense among investors that some landlords use Reits as vehicles to ‘dump’ unwanted and unattractive assets, Mr Churchouse said.

In addition, Reits are also not high-growth instruments, so investors who look for capital gains are not as keen on them. Mr Churchouse noted that the Reit sector now accounts for only 12-15 per cent of total invested real estate in the Asia-Pacific. He said he would like to see the proportion climb to 30-40 per cent in the future.

For Singapore, ratings agency Moody’s Investors Service this week reiterated its ‘stable’ outlook on Singapore-listed Reits (S-Reits) for the next 12-18 months.

‘We expect S-Reits to use their well-capitalised balance sheets to continue acquisitive strategies and assume they will fund potential acquisitions with a mix of debt and equity while maintaining leverage within targeted limits of 40-45 per cent,’ the firm’s analysts wrote in a note.

Stable outlook for S-Reits: Moody’s

CREDIT rating agency Moody’s Investors Service has maintained its stable outlook on real estate investment trusts in Singapore (S-Reits) over the next 12-18 months, on expectations of rising rents and loose credit conditions.

That many rated S-Reits carry investment-grade ratings ‘reflects issuers’ relatively stable operating incomes, high-quality assets, and low development risk’, said Moody’s analyst Alvin Tan in a report yesterday.

Moody’s expects Singapore’s economy to expand by 6.3 per cent this year, which should lead to increasing rental rates and high occupancies.

It noted, however, that the rate of rental hikes could be slower than that previously. This year’s economic growth is likely to pale in comparison to last year’s 14.5 per cent and a supply of new properties will also be coming onstream.

‘In our base case assumptions, we expect rental rates in the suburban retail and industrial segments to remain stable in 2011 and 2012, due to Singapore’s moderate economic growth and these rentals’ relative stability during the last economic downturn,’ Mr Tan said. In contrast, rents for the urban retail and commercial segments are expected to be more volatile, he said.

Apart from rising rents, a benign environment for refinancing will also benefit S-Reits, Moody’s noted. There is ample liquidity in the market and strong backing from sponsors for most S-Reits, Mr Tan said, adding that Moody’s expects interest rates to continue staying low this year.

He pointed out that most S-Reits have kept leverage in the 30-40 per cent range, which still compares favourably with their higher long-term targets of 40-45 per cent. Moody’s expects S-Reits to continue making acquisitions, funding these with a mix of debt and equity, while maintaining gearing within targeted limits.

‘We view industrial S-Reits, such as A-Reit (Ascendas Reit) and MLT (Mapletree Logistics Trust), as more likely to pursue growth by acquisition, because industrial properties have lower transaction values and higher yields compared to other asset classes,’ Mr Tan said.

‘By contrast, S-Reits focused on office properties continue to face challenges in finding yield-accretive properties due to high asking prices and low yields in this segment of the market.’

Safer bet in uncertain times

Rising in flation, low interest rate, and economic uncertainties are boon to S-REITs. Rising food, transport, and housing costs are likely to keep inflation high for a while in Singapore which saw CPI rose 5.2% YoY in 1Q11. With high inflation, S-REITs stand to gain from 1) rising spot rents, and 2) higher valuation of underlying properties. On the other hand, low interest rate environment (3m SIBOR: 0.4%) in Singapore, coupled with global economic uncertainties amidst unresolved issues caused by the global financial crisis, have resulted in reduced risk appetite. Given that S-REITs offer attractive dividend yield of 6.9% and inflation-protection features, we are OVERWEIGHT on the sector.

Rising spot rents to cushion negative rental reversion of office space, and raise positive rental reversion for others. Spot rents of industrial, office, and prime suburban retail space, have been rising sequentially for four consecutive quarters since 2Q10. We believe spot rents of non-residential properties, with the exception of urban retail space, will continue to rise further, underpinned by strong Singapore economy estimated to grow 5-7% YoY in 2011. Riding on the improving spot rents, S-REITs are set to enjoy better rental reversions, except for office REITs which are experiencing negative rental reversion in 2011.

Increasing tourist arrivals and high hotel occupancy to boost Average Daily Room Rate (ARR). Singapore’s tourism industry is set for multi-year boom with tourist arrivals projected to grow at 7.9%/year during 2010-2015 to hit 17m. This has resulted in high hospitality occupancy rate of 86% in 2010 (+9.8ppt YoY). We believe Singapore’s hospitality sector will continue to benefit from the strong tourism growth as a result of high occupancy rate and rising ARR.

Top picks are retail and hospitality REITs. We favour retail REIT with prime suburban exposure due to strong positive rental reversion as well as its defensive nature. Our top pick is Frasers Centrepoint Trust (FCT SP; BUY; new TP: S$1.77). On the hospitality front, we favour CDL Hospitality Trusts (CDREIT SP; BUY; TP: S$2.46) to benefit most from Singapore’s tourism boom.