S-REITs

Kim Eng on 22 Mar 2013

Reiterate NEUTRAL for S-REITs following uninspiring risk-reward profile as: (1) Yield spreads against ten-year bond yields continue to tighten with rising bond yields. (2) Downward pressures on rentals with slowing growth in Singapore.(3) Risk of asset-price declines in the event that monetary tightening is not conducted gradually (a case in point: Japan’s “lost decade” after the Finance Ministry sharply raised interest rates in late 1989). Our top picks remain only with the Retail REITs, in which the mismatch between rentals and physical prices have not proved unnerving. Reiterate BUY for CMT (TP: SGD2.36), SGREIT (TP: SGD0.95), SUN (TP: SGD1.85).

Gravity defying, but will QE-inflated asset prices sustain? S-REITs have registered an impressive price return of 5% YTD and 43% since end-2011. Their stellar performance in FY12 outshone even the major REITs markets in the US and Australia. Nonetheless, the rapid step-up in asset values (fuelled in the past years by quantitative easing [QE] policies) and the gradual creep-up in risk-free rate have skewed risks to the downside.

Let the buyers beware. Fundamentally, we believe that S-REITs stock price performance should be a function of forward DPU growth and physical asset prices. The almost 60% returns generated by S-REITs in 2005-2006 were buttressed by similarly outstanding DPU growth rates of 19-43% pa over 2005-2008 and strong growth in rents and capital values in 2005-2007 (in short, fundamentals-driven growth). However, the recent S-REITs 2012 rally was primarily fueled by QE-inflated asset values and ample liquidity, and not so much driven by underlying fundamentals such as strong DPU growth or rental upside, in our view.

Overheating asset prices but rentals not catching up. Post-GFC, retail and office properties have appreciated but rentals have been slow to catch up. This has in turn caused retail and office cap rates to compress from 5.9% and 4.4% in 2010 to 5% and 3.7% in 2012. Moving forward, we think it is unlikely that rentals will ever catch up in the near-term, given that the growth outlook in Singapore is expected only at 1-3% this year. Tenants are increasingly feeling the heat from escalating business costs and declining profit margins. Limited rental upside means that S-REITs are unlikely to have significant organic DPU growth anytime soon.

Rational Temperance. Unlike the “fundamentals-driven growth” experienced by S-REITs in 2005-2006, we expect the current “QE-inflated growth” to run out of steam once the “artificially compressed” interest rates in the US, and hence Singapore, start normalising sometime next year or early 2015. However, as markets are typically forward-looking, we expect S-REITs prices to rationalise probably in 2H13 or 2014.