S-Reits

Kim Eng on 28 Sept 2012

UK Road Show: Feedback & Response UK Marketing. We heard from a total of 14 UK-based fund houses spanning three days. 

Positive response on S-REITs.
• Most UK clients view S-REITs positively as it has one of the highest yield spreads amongst its peers, outperforming even major REITs markets such as US, Australia and Japan.  This was primarily attributed to the low risk-free rate environment in Singapore (10-year government bond trading at 1.44%) and the relatively higher physical cap rates (net property income that can be extracted per annum for each S$ dollar invested in investment properties), compared to other developed markets. 
• This year, we have seen many pension, insurance and income funds switching into REITs to pursue higher returns for the sheer fact that the yield-curve is almost flat. This is further aggravated by the almost “zero-bound yields” which meant that yields have no more room to fall, erasing any prospects of fixed income capital gains for investors. In the quest for returns, many such funds had to turn to slightly riskier asset classes such as REITs, Infrastructure Trusts and Master Limited Partnerships (MLPs) etc for stable recurring distributions.      
• We believe that with the latest round of QE3 Infinity, ECB’s unlimited bond-purchase program and BoJ’s yen-asset-purchase program, coupled with the low interest rate environment and a yield-spread of 440 bps over the 10-year government bond with low earnings risk, would warrant further yield compression of 56-73bps, translating to 11%-14% upside for the S-REITs sector. 
• Most funds do not expect any significant interest rates hike until end of 2015, following the US Fed’s intent to keep short-term interest rates near zero till then.       
• Given the macro-environment, strong SGD and lack of investable alternatives in the market, funds will continue to chase yields with underlying assets that are defensible. For those funds that are already vested, most stated that they will not be switching out of S- REITs as there are not many other options in the market. 

Focus shifting to Industrial and Retail REITs
• Most clients concur that Office REITs are staring to look expensive, having run up 42% YTD and 0.9x PBr. With the macro-environment looking uncertain and office landlords not thriving in an environment of falling rentals, many are turning to the more defensible Industrial and Retail REITs.
• Amongst the Industrial REITs, we prefer those with exposure to logistics/warehouse and business parks space for the fact that: average historic demand from 2011 onwards (net addition per annum) outstrip average supply. 
• We are, however, downbeat on the industrial/flatted space because of supply-demand shortfall and their close affiliation with the manufacturing sector (manufacturing output is down 2.2% YoY in Aug 2012. Excluding biomedical manufacturing, output fell 2.7%). Reiterate BUY on A-REIT (TP: SGD2.45) and MLT (TP: SGD1.17).
• Retail REITs are also deemed more defensible because tenants hold inventory and some are backed by necessity shopping. Our retail picks are SGREIT (TP: SGD0.81) and CMT (TP: SGD2.25). 

 Iskandar Development not a near-term threat
• Some clients raise concerns about the Iskandar Development at South Johor posing a pricing threat to Industrial landlords in Singapore. 
• We take the view that it may still take a while for Iskandar Malaysia to build up the whole ecosystem before it can erode Singapore’s competitive advantage.
• For example in the Logistics/Warehouse space, most of the storage assets are located strategically near our airport or sea-ports (PSA and Jurong Port). Singapore has been known for years as a entrepot port and transshipment hub. It is unlikely that Iskandar Development can replicate all this in the near term.