REIT - Positioned for a recovery

Investment summary
• S-REITs have rebounded by 56% from March low, in line with 60% for the STI. The S-REIT sector has rebounded strongly from its all-time low in Mar 09, attributed to a strong inflow of foreign funds. Correspondingly, yield expectations have abated from an all-time high of 17% to 11%.

• Recapitalised; refinancing concerns largely averted. REITs have gone beyond the successful refinancing of debt to recapitalisations in a bid to strengthen their balance sheets for the recession ahead. Sponsor-backed REITs including Ascendas REIT, CapitaMall Trust, CapitaCommercial Trust, Starhill Global, and Frasers Commercial Trust went to the market and raised a combined S$3bn of equity. Average asset leverage for REITs under our coverage has retreated to 32% from 35%. Interest cover also appears healthy at 4.5x vs. the typical lenders’ requirement of 2x. We consider balance sheets to be relatively healthy.

• Positioned for a recovery. The larger environment looks positive for investing in REITs, underpinned by: 1) expected high liquidity and low interest rates; and 2) the Singapore government’s continued support for the REIT industry.

• We are most optimistic on hospitality and retail sub-sectors, which we believe will be major beneficiaries of the following in 2010: 1) the completion of the two integrated resorts (IRs); 2) a change in the marketing of Singapore as a standalone destination for tourists; 3) an expanded transport infrastructure with more rail lines; and 4) the anticipated return of corporates and expatriates as Singapore grows more cost-competitive against its regional peers.

• Neutral on industrial sub-sector. The outlook for both the manufacturing and logistics industries remains weak, and we expect the businesses of industrialists in factory and warehouse space to be under pressure. We expect occupancy for industrial space to lag behind the actual slowdown in industrial businesses, holding out the downturn for industrial properties for longer.

• Negative on office sector. We expect occupancy to hold up with the return of corporates as Singapore grows more cost-competitive vis-à-vis the region. However, rents are expected to remain under pressure from three continuous years of strong potential supply and shadow space.

• Overweight on S-REITs; top picks are Suntec REIT and CDLH-HT. We retain our Overweight position on REITs. Our top picks are CDL-HT and Suntec REIT on the back of their lower valuations and near-term catalysts. Dividend yields are also attractive at 9% and 10% respectively. CDL-HT’s Singapore concentration makes it the best proxy for a tourism revival in Singapore. Suntec REIT’s Suntec City Developments (87% of gross revenue) is the closest sizeable retail cluster to the Marina Bay Sands IR and one of the major beneficiaries of two MRT stations opening next to it. We also have Outperform ratings for FCT, ART, PLife.


General environment is positive
Beyond balance-sheet and debt issues, we believe that the outlook for REITs’ growth is more positive than a year ago. Contributing factors are expected high liquidity and low interest rates and the Singapore government’s continued support for the REIT industry.

High liquidity and low interest rates
Ample liquidity and low interest rates likely to sustain yield spread. Since the collapse of Lehman Brothers, sharply higher borrowing costs have cast a pall on REITs’ ability to finance acquisitions and refinance debts. However, with most of the S-REITs proving their ability to refinance debt and the easing of medium-term swap offer rates, such concerns have abated. Additionally, concerted global monetary easing has lifted liquidity conditions in recent months. Our regional strategists have analysed key liquidity indicators, namely M1 to GDP, foreign fund flows and market turnover to market capitalisation (velocity) for a gauge on where excess liquidity may drive Asian markets. They conclude that on the global front, US M1 growth has been unprecedented and the widely used LIBOR benchmark has fallen to a historical low.
Judging from previous recessions, they believe that the era of low interest rates has only begun and short-term risk-free rates could stay low for a year or two, at the least.
Implications for the Asian markets we cover are positive. Based on M1 to GDP and velocity measures, Singapore, Hong Kong and Malaysia stand to benefit the most.
With M1 to GDP at a historical high, these three markets could gain the most from liquidity drivers, in our view.
Further on rates, SIBOR has a close correlation with LIBOR. Hence, we are expecting SIBOR to stay low longer with weak global growth.
An environment of ample liquidity and low interest rates is highly positive for REITs, which should benefit from easier access to funding as well as cheaper financing.
US and Singapore 10-year bond yields maintain an attractive spread of 690bp and 780bp respectively, to average REIT yields.

Hospitality and retail are our preferred sub-sectors
We are most optimistic on the hospitality and retail sub-sectors, which we expect to be major beneficiaries of certain catalysts in 2010: 1) the completion of Singapore’s two IRs; 2) a change in the marketing of Singapore towards a standalone tourist destination; and 3) an expanded transport infrastructure with more rail lines. The biggest stock beneficiaries should include CDLHT-HT, Ascott REIT, Suntec REIT, and Frasers Centrepoint Trust.

Tourism and infrastructure catalysts
The IR catalyst to benefit retail and hospitality subsectors
Profound changes in Singapore’s tourism industry; impact on hospitality and retail REITS. We anticipate sea changes for Singapore’s tourism sector after the opening of its two IRs by 2010, when a seamless chain of attractions around the Marina Bay area would be created. Orchard Road and other attractions are also scheduled for rejuvenation. All this would have a profound effect on Singapore’s economy and employment, auguring well for the retail sector which should benefit from both increased tourist and domestic spending; as well as the hospitality sector which should benefit from increased visitor arrivals and increased length of stay.

Change in the marketing of Singapore. Officially, Singapore wants to book annual tourist receipts of S$30bn (S$15bn in 2008), tourist arrivals of 17m (10.1m in 2008) and an average length of stay of 4.5 days (3.7 days in 2008) by 2015. These goals are showing initial signs of success. Recent talks with Genting Singapore indicate that Genting remains confident of drawing in 4.5m-5.5m visitors to Resorts World in its first year of launch. With the combined draw of the two IRs and Universal Studios, Chinese and Indian tour agencies are, for the first time, positive about marketing Singapore as a single tourist destination in their respective markets. This is a significant improvement over their traditional marketing of Singapore as a stop-over destination, or lumped together with its neighbouring countries Malaysia, Thailand and Indonesia.
Additionally, non-gaming elements in the two resorts such as Universal Studios and conference facilities should attract more family-oriented visitors, as well as BTMICE (business travel, meetings, incentives, conventions and exhibitions) audiences.
Comparisons with the established gaming markets of Las Vegas and Macau show that family-oriented and BTMICE visitors have a much higher propensity for retail spending than less family-oriented and non-BTMICE gamers. For these two reasons, the outlook for sizeable retail clusters in close proximity to the two resorts is positive.
Hotel supply within IRs insufficient to meet demand. We maintain that increased tourist arrivals generated by the IRs will exceed what the IR hotels can absorb, thus benefiting existing hotels. We add the following scenario for illustration.
In a press release dated 19 Feb 09, Resorts World said that it expects to welcome 15m visitors in its first year of operation. Assuming that demand is eroded by about a third by the global recession and only 11m visitors arrive, of whom 4.5m are Singapore residents who will not require hotel accommodation, and assuming only one day of stay on a twin-sharing basis for foreign guests, there would be 3.25m room nights generated by Resorts World. Around 11,130 rooms would be required, assuming an average hotel occupancy rate of 80% on a daily basis to meet the demand. This would be three times what the two IRs can accommodate, and also more than the 9,950 new rooms coming up in the next four years. Hence, we believe that the success of the two IRs will create strong spillover demand to benefit hotels outside the two IRs.
We believe that centrally-located, mid-priced hotels can best tap the demand from both families and BTMICE visitors.

Increased accessibility and catchment population.
A number of infrastructure works is in progress in the Marina Bay area. They include the construction of two Circle Line MRT stations, Esplanade and Promenade, scheduled for opening in 2010.
The Promenade station will also serve as the interchange station for the Downtown Line that will link Marina Bay Sands IR (MBSIR) to all four major rail lines. Promenade will be one station away from Bayfront Station, the gateway to MBSIR.
Furthermore, a pedestrian bridge will be built to link the MBSIR with the Marina area. This bridge is part of the URA’s plan to build a 3.5km promenade linking the necklace of attractions around the bay. Attractions that will form part of the S$35m waterfront promenade include a 300-m long steel structure, water features and a shaded tropical walk. We expect Suntec REIT to be a key beneficiary of the infrastructure works as the catchment population of Suntec City, its key asset, is expected to expand materially with the opening of the two stations.

Staying negative on office sub-sector
Office: large potential supply and shrinking demand. Historically, there is a close correlation between Singapore’s GDP performance and office space demand. Both the government and our house are expecting Singapore’s GDP to contract this year, by 5-9% yoy. As such, we expect new demand for office space to weaken further. Additionally, Jones Lang LaSalle (JLL) forecasts that office supply will be significant over the next five years at 9.8m sf, equivalent to a 2.7% increase p.a. on current supply of 72.2m sf. The projection takes into account known delayed projects, including City Development’s South Beach development, which is located close to
Suntec City. With potential new supply and shrinking demand, occupancy levels are expected to move further south.

Shadow space may prolong rental depression.
Shadow space is excess office space that companies have leased but are looking to sublet to third parties. Colliers estimates that office shadow space had increased 48% in a short span of two months, from 250,000 sf in Mar 09 to 370,000 sf in May 09, with more than half contributed by the two key micro-markets of Raffles Place/New Downtown and Marina/City Hall. This is equivalent to 0.5% of islandwide office supply. The sharp increase has intensified the competition for tenants and exacerbated the downward pressure on rents. As a result, some landlords are resorting to incentives such as rent holidays in addition to competitive closing rents, some of which are 25-30% below asking rents. Hence, effective rents have fallen by more than what signing rents are indicating.
We expect the availability of shadow space to peak in 2010, as a number of financial institutions had pre-committed to a large amount of space in yet-to-be completed offices or business park buildings in the last two years. An estimated 400,000-600,000 sf of additional shadow space could enter the market in 2010, from financial institutions alone. Increased shadow space is expected to prolong the rental depression and delay a market recovery until after 2010. Colliers forecasts that by the end of 2010, average monthly gross rents for Grade A office space in the Raffles Place area could reach the mid-2005 level of S$5.00psf/month, although this would remain above the S$3.95 seen at the bottom of the market in 2004 Occupancy to be supported, but rents likely to stay low. With still lower rents than its regional peers, a stable political environment, and relatively low tax rates, we believe that Singapore will grow increasingly attractive to multi-national corporations which need to be established in this part of the world. We expect occupancy levels for prime office space to be supported by the gradual return of expatriates, who are attracted by Singapore’s cost-competitiveness. Nonetheless, a large supply and global recession could continue to keep office rents low.

Maintain Overweight on S-REITs; CDLHT and Suntec REIT are our top picks.
Overall, we are most positive on hospitality and retail on visible catalysts in the next 12 months, including the IRs and a possible return of expatriates to Singapore. Within these two sub-sectors, we prefer CDL-HT for its Singapore concentration, which makes it the best proxy for a tourism revival in Singapore. Suntec REIT’s Suntec City Developments (87% of gross revenue) is the closest sizeable retail cluster to the Marina Bay Sands IR and should be one of the major beneficiaries of the two MRT stations opening next to it.
We are Neutral on the industrial sub-sector. A weak outlook for the manufacturing and logistics sectors and intensifying rental competition from Grade A office space largely diminish the potential for higher rental reversions, although occupancy is more likely to stay stable given long leases for all our three industrial REITs. Our top industrial picks, AREIT and MLT, are nearing our target prices.
We remain negative on the office sub-sector on the back of a large supply overhang over the next three years. We believe that cheaper rents will eventually lure back demand, particularly to newer, quality office buildings. However, we are doubtful that the demand will be strong enough to revive rents to 2007 levels. Valuations appear low now at 0.5x P/BV against the sector average of 0.6x. However, with more asset devaluations expected and a lack of near-term catalysts, we expect limited upside potential for share prices.
Our top picks for the REIT sector are CDL-HT and Suntec REIT for their valuations and near-term catalysts. Dividend yields are also attractive at 9% and 10% respectively.

Suntec REIT
• Maintain Outperform. We believe there is room for upside surprises from SUN’s retail segment, from a higher catchment population after the opening of two new MRT stations at Suntec City, and direct linkage to the Marina Bay integrated resort. Additionally, Chinese and Indian tour agencies are starting to market Singapore as a single tour destination over their traditional marketing of Singapore as a stop-over destination. This change should have a significant impact on the length of visitors’ stay in Singapore, and hence retail spending.

• Supply overhang in office; but cost-competitiveness also increases. New office supply of 9.8m over the next five years as well as 400,000-600,000 sf of potential shadow space from 2010 is likely to depress a rental recovery. On the other hand, this development should also improve Singapore’s cost-competitiveness vs. its regional competitors, Hong Kong and Tokyo. We expect continued low rents to support occupancy. A pick-up in leasing volumes in recent months is a sign that occupancy could turn out less depressed than expected.

•DDM-derived target price of S$1.07 (discount 9.4%). We like Suntec REIT for its: 1) quality office and retail portfolio; 2) low leverage of 34.4%; 3) absence of refinancing concerns until 2011; and 4) severely discounted price for a possible fall in asset values. We believe that downside risks for the office sector have been factored into its share price while upside surprises from its retail segment have largely been neglected.

Suntec REIT is the first mixed commercial real estate investment trust (REIT) to be listed in Singapore, in Dec 04, owning prime retail and office space in Singapore’s Central Business District. From two properties (Suntec City Mall and Suntec City Office Towers), Suntec REIT now has five properties. The three additions are a onethird stake in One Raffles Quay (ORQ), Park Mall and Chijmes. Its portfolio value had more than doubled from S$2.2bn at the time of listing to S$5.4bn as at 31 Dec 08, with 1.9m sf of office space and 1m sf of retail space under management. As at 31 Mar 09, office occupancy was 97.4% and retail occupancy, 98.8%.