OVERWEIGHT Maintained
Positive underlying tone
We recently hosted nine Singapore and Malaysia REITs at our inaugural Asean REIT conference. While investors were generally not pricing in a double dip, most appeared increasingly cautious. Coupled with value emerging from the recent selldown, we sensed increased interest in REITs, with a particular preference for those in more resilient segments like industrial, retail and healthcare. The overall tone from REITs was also positive; they had yet to notice any ramifications from the slowdown in advanced economies, though they would be monitoring developments. Growth among Malaysian REITs was intact. We continue to expect REITs to outperform in the current environment of risk aversion and low interest rates and with stronger balance sheets after the global financial crisis. Our top picks are AREIT, FCOT, Starhill and Cache. We also like CMT and CDLHT at current valuations.
Takeaways
Gravitating towards REITs with market uncertainties. During the conference, we sensed increased caution among investors after the recent market selldown, with more turning to S-REITs given increased risk aversion. Most REITs also gave the feedback that they had been receiving more investor interest and enquiries. While turning cautious, investors were not yet pricing in a double dip. Questions centred on rental growth and expansion via acquisitions or development. Most agreed with us that S-REITs have emerged with stronger balance sheets and portfolios from the last crisis. We also sensed increased interest in S-REITs among Malaysian investors, which we attribute to the recent high-profile REIT listings in Malaysia such as CMMT and Sunway REIT.
Still positive; though increased risks noted. Recent market volatilities and developments in advanced economies have not affected REITs yet. Notwithstanding slowing growth in advanced economies, industry participants remained positive on growth in the region. However, most would be monitoring developments closely. Industrial REITs continued to expect positive rental reversions on the back of rising spot rentals and rental step-ups. Investors liked the stability from industrial leases but were slightly wary of a seeming slowdown in manufacturing in Singapore.
Industrial S-REITs, however, noted that manufacturing remains a core component of Singapore’s economy and continued to see bright spots as local manufacturing transitions to higher-value-added products and services.
Optimism among office REITs slightly more tempered. While spot rents for most office S-REITs remained healthy, more investors were starting to question rental growth next year. We noted a moderation in tone among the office S-REITs, on the back of a slowing leasing momentum, significant physical completions in 2012 and potential growth concerns. Most expected rental growth to be more moderate in 1H12, before picking up again in 2H12 as supply tightens in 2013.
Acquisition environment remains difficult, locally. Most REITs remained keen to grow via acquisitions. Opportunities are, however, limited with the system still flush with liquidity. Industrial REITs noted a difficult acquisition environment, given increased competition from new entrants such as private funds, smaller players and other industrial REITs. Most were thus gravitating towards development (mainly buildto-suit) and redevelopment, given their enhanced yields, the small capital outlays, short gestation periods and REITs’ ability to mitigate leasing risks by building to suit. Similar concerns on compressed yields and a lack of quality assets for acquisition were expressed by the office S-REITs.
S-REITs
AREIT (Outperform, TP: S$2.15). Many investors agreed with us that AREIT was one of the more defensive names with its rents generally stable despite swings in prime office rents. AREIT noted an increasingly difficult local acquisition environment with increased competition and limited investment-grade assets for acquisition. That said, management continued to see opportunities in business parks. While overseas acquisitions remained an option, management continued to give priority to local business-park acquisitions and build-to-suit projects. Management was also specific about its overseas expansion, pointing to China’s business-space assets for now. Should the Iskandar project take off, Malaysia could be of interest further down the road though it cited a lack of critical mass and skilled labour as deterrents for now.
Cache (Outperform, TP: S$1.15). Investors mostly appreciated Cache’s stability but were concerned about concentration risks and growth. Investors noted Cache’s dependence on master lessees, CWT and C&P. Management, however, believed that this risk could be mitigated by: 1) the strength and clout of CWT and C&P in the logistics space locally; and 2) the quality and location of Cache’s assets which should reduce the difficulty of filling up space even when tenants move out. Investors were split on Cache’s recent maiden overseas acquisition. While some thought Cache should stay local given familiarity and economies of scale, others saw growth opportunities from going overseas. Management reassured investors that Singapore would remain its core market. Nonetheless, with the government controlling the new supply of warehouse space, going overseas would be pertinent to its growth.
CCT (Underperform, TP: S$1.25). Discussions centred on its office portfolio and the redevelopment of the Market Street Car Park. The CEO continued to guide for negative rental reversions for 2011 and possibly 1H12 though Six Battery Road has been signing up rents at a healthy S$13 psf. Vacancy at Six Battery Road and Capital Tower had quickly been filled by expansion by existing tenants. Management did concede that the demand for large office space has slowed with the bulk of the leasing having taken place last year. Meanwhile, it remained optimistic of achieving a 6% yield on costs in 2014 for the Market Street Car Park on completion, in view of limited office completions in that year. While investors appeared less sanguine on offices given near-term negative rental reversions, some noted CCT’s stronger balance sheet in this cycle, following its success in refinancing a chunk of its CMBS recently. Management did not foresee difficulties in refinancing its 2012 loan and could seek to unencumber Capital Tower should the interest-cost differential be minimal.
FCOT (Outperform, TP: S$0.91). Investors were keen to hear management’s views on the potential redevelopment of KeyPoint into a mixed residential and commercial development. Management explained that this move was still exploratory, primarily motivated by a potential capital-value uplift upon conversion from office use (S$913 psf) to residential/retail use, given the property’s proximity to the Nicoll Highway MRT station. Funds could be used to redeem its 5.5% CPPU and for acquisitions. Investors were also curious on its acquisition pipeline and timeline. While FCOT has a pipeline from its sponsor, management noted that its sponsor may not be keen to sell in the current market and it might not be easy for FCOT to inject assets in an accretive manner given its current high trading yields. On refinancing, management remained sensitive to current markets risks and would time its refinancing in accordance with market conditions.
MIT (Outperform, TP: S$1.24). Discussions centred on organic growth and acquisitions. MIT remained positive on its organic growth given an under-rented flatted factory portfolio, the removal of rental caps since Jun 11 and pockets of growth within the local manufacturing scene. While tender pricing for Tranche 2 of the JTC divestment appeared aggressive, management saw the potential for stronger reversionary rents given a well-located portfolio and with rents significantly below JTC’s posted rents. In terms of acquisitions, management noted that its sponsor actually has no more assets in its portfolio while JTC is unlikely to divest more flatted factories in the near term. However, MIT noted opportunities for extracting returns from build-to-suit projects by tapping unutilised GFA in parts of its portfolio.
PLife REIT (Outperform, Target price: S$2.05). Investors liked the resilient and inflation-proof portfolio of PLife. Key concerns revolved around its Japanese exposure and acquisition growth. As an unfamiliar market and asset class for most investors, management shared the rationale and operating metrics of its Japanese nursing homes. Some asked about insurance coverage after the earthquake. Management explained that there has always been insurance coverage for its Japanese assets but coverage has since been expanded after the earthquake. Current coverage includes business disruptions after earthquakes. PLife is still in talks with Malaysian operators (both third parties and sponsor, Khazanah) for acquisitions. Other overseas markets it is interested in include Australia.
Suntec REIT (Underperform, TP: S$1.38). Management remained positive on Suntec City’s offices. However, given physical completions expected next year and a slowing leasing momentum, management would try to protect occupancy. Rents at Suntec City Mall are stable and within management control. Its recent acquisition of the Suntec Convention Centre ties in with its AEI plans for Suntec City Mall. While management remained tight-lipped on its plans, it highlighted the good location of the convention centre. Management will also seek to minimise income disruption from any AEI. While there are potential refinancing risks given a climbing gearing, management highlighted its ability to refinance even during the trough of the last crisis. It reiterated that there would be no equity fund-raising, given that any AEI would be completed in phases, allowing for the progressive drawdown of loans.
M-REITs
Investors were generally less familiar with the two Malaysian REITs and their assets and had the opportunity to learn more during the sessions. In contrast to S-REITs, Malaysian REITs appeared to be in a growth phase, with both REITs having added to their portfolios.
CMMT (Outperform, TP: RM1.35). Discussions revolved around its recent acquisition of Kuantan Mall. Though most had limited knowledge of the mall, they appeared convinced by the CEO that there would be positive rental reversions going forward. NPI yield was a healthy 7%. Management also saw tremendous room for asset enhancement, which was one of its main reasons for the purchase. Overall, investors appeared impressed with the group’s track record in managing retail malls and liked its focus on suburban necessity malls.
Sunway REIT (Not rated). Management shared its recent acquisition of Putra Place and clarified on the REIT’s ongoing litigation with the former owner of the asset. Management was excited about the purchase given its attractive pricing and capital appreciation potential. On its ongoing litigation with the previous owner, management maintained its optimism on a resolution by 4Q11. Management was also confident on organic growth and hoped to achieve annual DPU growth of 5%. Particularly, it expected to benefit from the Economic Transformation Programme in Malaysia and population growth in the Bandar Sunway region. Other growth drivers include an acquisition pipeline from its sponsor and shopping-mall AEI.
Valuation and recommendation
Maintain Overweight. We continue to expect REITs to outperform in the current environment of risk aversion and low interest rates and with stronger balance sheets after the global financial crisis. Our top picks are AREIT, FCOT, Starhill and Cache. We also like CMT and CDLHT at current valuations.
