Singapore Reits - Right ingredients

S-Reits is in a sweet spot.
While healthy underlying fundamentals should translate into quality 4Q10 earnings, the depressed interest rate environment will benefit the sector through lower refinancing costs and provide cheap funding for yield accretive acquisitions. Furthermore, CLSA’s expectation of a strengthening SGD (S$1.15/USD by end of 2011) will garner higher interest among foreign institutional investors which are currently subjected to a 10% withholding tax. Maintain Overweight.

We expect no surprises for 4Q10
􀂉 We expect 4Q10 earnings outlook for S-Reit to be in line with our expectations.
􀂉 3Q10 revenue growth of 1.1% QoQ and 5.9% YoY were driven by both organic and inorganic growth, we expect the trend to sustain going into 4Q10.
􀂉 Rising occupancies, positive rental reversions and contribution from acquisitions were key trends over the past few quarters.
􀂉 Sector Ebitda margins improved by 90bps QoQ but slipped by 50bps YoY as a result of the cessation of property tax rebates from by the government.

Interest rates to remain depressed
􀂉 CLSA’s economics team forecasts interest rates in Singapore to remain low till 2012 with SIBOR at 0.20% over this period.
􀂉 Depressed interest rates will continue to benefit the S-Reits through lower cost of debt and provide cheap funding for acquisitions in the next 12 months in our view.

S-Reits to benefit from currency appreciation
􀂉 SGD1.3016/USD is currently near a 10year low.
􀂉 Expect MAS to combat rising inflation (6.7% CLSA 2011 forecast) by further appreciating the currency in 2011. CLSA forecast this to hit SGD1.15/USD by 2011.
􀂉 This suggests an 11.6% currency appreciation, fuelling interest among US and foreign based funds which are currently subjected to a 10% withholding tax.
􀂉 Local Reits are beneficiaries – CMT, AREIT, CREIT, Cache, MIT, Suntec, FCT

Maintain Overweight
􀂉 With healthy sector fundamentals, we continue to maintain Overweight on S-Reits.
􀂉 Further catalysts in the sector include lower average cost of debt through debt refinancings and DPU growth through yield accretive acquisitions.
􀂉 The appreciating Singapore dollar also positions the sector well for overseas investors providing solid yields with potential currency appreciation.
􀂉 We like the Retail, Industrial and select office Reits. (ART, AREIT, Cambridge Reit, MLT, CMT, FCT, KREIT and Suntec Reit).

We expect no surprises for 4Q10
We expect 4Q10 earnings outlook for S-Reit to be healthy with the first results kicking off next Monday. 3Q10 revenue growth of Reits under our coverage showed a 1.1% QoQ and 5.9% YoY increase and we expect the trend to sustain into 4Q10 driven by both organic and inorganic growth. Most of the Reits under our coverage benefitted not only from rising occupancies and positive rental reversions but also new earnings contribution from acquisitions made in 2010.

Reits which benefitted from higher occupancies include Suntec Reit, Ascott Reit and CMT. Meanwhile, K-Reit and Cambridge Reit which divested part of their portfolio saw negative growth sequentially. However, we expect topline growth to improve as K-Reit’s MBFC phase 1 acquisition starts to contribute in 1Q11 and Cambridge Reit continues on its acquisition expansion mode.

Sequentially, Ebitda margins for the sector also improved by 90bps QoQ but slipped by 50bps YoY as a result of the cessation of property tax rebates granted by the government in 2010. Along with the acquisitions, higher trust expenses, management fees and maintenance expenses also contributed to the margin erosion on a YoY basis.

Interest rates to remain depressed.
The depressed interest rates in Singapore will continue to benefit the S-Reits both in terms of refinancing as well as providing cheap funding for acquisitions in the next 12 months. CLSA’s economics team forecasts interest rates in Singapore to remain low till 2012 with the Singapore interbank offer rates at 0.20% over this period. With such low interest rates, we expect asset acquisitions in the sector to gain further traction. Cross border Reits would better positioned as they are able to tap into higher yielding assets outside of Singapore in our view.

S-Reits to benefit from currency appreciation
The SGD currently at SGD1.3016/USD is near a 10year low and just 1.5% above the all time low of SGD1.2822/USD on 4th November 2010. We expect the Singapore dollar’s strength to persist throughout 2011 driven by MAS’s policy to combat inflation (CLSA forecast of 6.7% in 2011) through appreciating the SGD currency. Our economics team forecast the Singapore dollar to touch SGD$1.15/USD by end of the year and even lower at SGD$1.13/USD by end of 2012. This suggests that the SGD could potentially appreciate by a further 11.6% by end of the year.

The prospect of an appreciating currency could level the playing field for US based funds and generate a higher level of interests in the S-Reits sector among these US based funds. Currently, foreign institutional investors are subjected to a 10% withholding tax on distributions from the Reits. With the forecast of an 11.6% appreciation in the SGD/USD, the 10% withholding tax impact will essentially be negated in our view. Key beneficiaries among the SReits include purely Singapore focused Reits, CMT, AREIT, Cambridge Reit, Cache Logistic, Mapletree Industrial Trust, CCT, Suntec Reit and Frasers CentrePoint Trust.

Maintain Overweight
With healthy sector fundamentals, we continue to maintain our Overweight on the S-Reits. Further catalysts in the sector can come in the form of lower average cost of debt through debt refinancings in the low interest rate environment as well as DPU growth through yield accretive acquisitions. The appreciating Singapore dollar also positions the sector well for overseas investors providing solid yields with potential currency appreciation. In this space, we like the Retail, Industrial and select office Reits. Stocks which we have a positive recommendation includes ART, AREIT, Cambridge Reit, MLT, CMT, FCT, KREIT and Suntec Reit.