SINGAPORE (July 23): A recent report by Soochow CSSD Capital Markets (SCCM) points out that investors are concerned about locally listed real estate investment trusts (REITs) expanding into Europe. For instance, although Frasers Logistics and Industrial Trust has assets in Australia that are viewed as very stable, it acquired a platform and portfolio in the Netherlands and Germany, which are in the midst of the brewing trade war between the EU and the US that could dampen demand for warehouses.

“Investors are raising doubts on [Singapore REITs’] expansion of their investment mandate to Europe, citing lack of established platform for some names (such as Ascendas REIT, Capi­taLand Commercial Trust [CCT]) and lack of scope to accumulate portfolios with scale. Investors prefer large-cap S-REITs to remain as pure Singapore plays,” SCCM says.

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As the trade war heightens and investors shun developers — to gauge the impact of Singapore’s new cooling measures — REITs are an obvious place to hide. They should provide most of their returns through distributions per unit (DPUs) and, despite rising interest rates, are generally less volatile than pure equity.

Credit Suisse says, based on its research, historical data on REIT yield spreads suggest that the average yield spread was much tighter before the global financial crisis, when rates were higher, implying the potential for compression in this spread if rates rise. “This compression has been seen in recent years when the 10-year government bond yield was at the higher end of its range at around 2.5%,” Credit Suisse says. The yield of 10-year Singapore Government Securities is the local risk-free rate. As at July 10, this yield stood at 2.44% versus the average REIT yield of 6.7%, translating into a yield spread of 4.26%.

Whether S-REITs can maintain their yield spread depends very much on DPU growth — which in turn is a function of the rental cycle, leasing strategy, capital management and funding costs.

DPU growth from local assets are a problem. Because of limited investible local assets, REITs are increasingly looking overseas for growth. Two REITs that are likely to continue acquiring Singapore properties because of their pipelines and right-of-first-refusal (ROFR) assets are Mapletree Commercial Trust (MCT) and Far East Hospitality Trust.

CapitaLand Mall Trust and Frasers Centrepoint Trust are also still pure S-REITs. However, there is a concern that CMT may follow its sibling CCT, to acquire a property in an overseas market without a platform or portfolio. FCT has a Singapore pipeline with Waterway Point, and eventually with Northpoint City South Wing, but it has articulated that it has a mandate to acquire in Australia and Malaysia.

Analysts appear to like CDL Hospitality Trusts (CDLHT) because of its exposure in Singapore. The local hotel sector has more or less digested the large bump in supply of 2016 and 2017. Revenue per available room (RevPAR) has been rising steadily for the first four months of the year, and is up 5.7% y-o-y versus a 1.7% y-o-y decline for last year.

Meanwhile, visitor arrivals have been steadily rising. In 2017, the Singapore Tourism Board (STB) announced visitor arrivals of 17.24 million, up 6.23% y-o-y. For the first four months of this year, visitor arrivals stood at 6.18 million, up 6.7% y-o-y.

“Average day rates and RevPAR increased for three consecutive months between February and April, indicating that market performance is beginning to turn,” notes a CBRE report. Analysts are similarly upbeat. “[Singapore hotels] may enjoy tailwinds as the market digests the surge in 2017 supply and [expects] this [supply] to taper off over the next three years. We project Singapore hotel RevPAR to rise 2% a year in 2018/19,” says an SCCM report on CDLHT, one of its top picks.

“The strength in its Singapore portfolio may offset potential weakness for its exposure in regional markets,” the SCCM report says. “While regional markets faced pressure (stiff competition in Japan and Germany, travel disruptions in Maldives and the UK), CDL HT’s Singapore segment reported firm performance (RevPAR +0.8% y-o-y in 1QFY2018),” the report adds. Singapore contributed 58.2% to net property income (NPI) in the first quarter. Analysts have an affinity for CDLHT because it is liquid and has a strong sponsor.

Two pure Singapore hospitality trusts are OUE Hospitality Trust and Far East Hospitality Trust (FEHT). The former should ideally be a beneficiary of the hotel sector recovery. However, its sponsor OUE has issued $150 million worth of exchangeable bonds, exchangeable into stapled securities (units) in OUEHT. OUE holds 659.2 million units, or 36.34%, in OUEHT.

Although its maturity date is in 2023 and the conversion price is way above the current unit price, the EBs may dampen sentiment.

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FEHT, whose ultimate parent is Far East Organization, has been somewhat neglected, and is now at a 2018 and one-year low. This is largely because its DPU since IPO in 2012 has been on a declining trend (see Chart 1), as the local hotel sector suffered from oversupply from 2014. That supply has since tapered (see Chart 2). For 2018, STB estimates growth in visitor arrivals of up to 4% to 18.1 million.

Qantas rebased its largest transit hub outside of Australia from Dubai to Singapore in March; and the Singapore Fintech Festival and Singapore as Asean chair are likely to boost the meetings, incentives, conferences and exhibitions (MICE) sector and visitor arrivals. All this, along with increased air connectivity, is expected to be demand drivers for the local hospitality market.

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FEHT fulfils many of the attributes of a defensive stock. It owns 12 properties valued at $2.38 billion, eight of which are hotels, mainly in the mid-tier range, and four serviced residences that cater largely for the corporate sector. FEHT carries no currency risk, its gearing is relatively modest at 34.4% and it now has a clear growth path.

In April, FEHT completed the acquisition of Oasia Downtown. The hotel cost $210 million, or $668,789 a key.

In addition, a 20-year master lease arrangement with its sponsor guarantees a minimum rent of $6.5 million a year. There is a variable rent of 33% of the hotel’s gross operating revenue, as well as 25% of gross operating profit less fixed rent annually. If the variable rent is a negative figure, the variable rent will be deemed to be zero, and the REIT’s unitholders will just receive the minimum rent. All hospitality REITs have either master leases or minimum guaranteed rents in place, and a variable rent or variable revenue to counter the sector’s volatility.

Based on pro forma numbers for the first nine months of FY2017 and the REIT’s funding options, the acquisition will boost DPU by 0.12 cents, or 4%, based on the DPU of 2.97 cents, to 3.09 cents.

Other ROFR properties comprise the 207-unit Orchard Scotts Residences, 225-unit Orchard Parksuites, 51-room Village Residence West Coast, 37-room AMOY Hotel and 116-unit Oasia West Residences.

FEHT holds a 30% stake in a development project in Sentosa comprising three hotels and a total of 839 rooms. The 606-room Village Hotel at Sentosa, which serves the mid-tier market, and the 193-room The Outpost Hotel, which serves the upscale market, are expected to be completed by 2H2018. The Barracks Hotel, comprising 40 luxurious guest rooms and suites in the heritage buildings, will follow as the second phase in 2019.

Havard Chi, director and head of research at Quarz Capital Management, expects FEHT’s DPU to rise to 4.13 cents this year compared with 3.9 cents in FY2017, and a further 7% in FY2019 to 4.42 cents. Units in FEHT are trading at 0.7 times its net asset value of 90.3 cents.

MCT’s robust local pipeline

MCT has resisted the temptation to go overseas, unlike its siblings Mapletree Industrial Trust and Mapletree Logistics Trust. MCT owns VivoCity, Singapore’s largest mall, located in the HarbourFront Precinct; Mapletree Business City I (MBC I), an integrated office and business park complex with Grade-A building specifications; three office buildings — PSA Building, Mapletree Anson and Bank of America Merrill Lynch Harbourfront; and Alexandra Retail Centre. The portfolio, which has a net lettable area of 3.9 million sq ft, was valued at $6.68 billion as at March 31.

On June 29, MCT increased the limit of its multi-currency medium-term note programme to $3 billion, from $1 billion. This led OCBC Credit Research to point out that MCT could be preparing to acquire MBC II, which comprises 1.186 million sq ft, and which OCBC estimates is valued at $1.32 billion. For MCT’s gearing to stay at or below 40%, its debt headroom would be limited to $400 million and it would require equity to acquire MBC II. MBC I, which cost $1.78 billion, was acquired in 2016 with a combination of borrowings, private placement and preferential equity fundraising.

Other properties that MCT’s sponsor Mapletree Investments owns are HarbourFront Centre, HarbourFront Tower One, HarbourFront Tower Two, PSA Vista and St James Power Station.

DPU for the 12 months to March 31 rose 4.9% to 9.04 cents, underpinned by full-year contribution from MBC I and higher revenue from VivoCity and Bank of America Merrill Lynch HarbourFront. VivoCity’s tenant sales grew 0.7% in FY2017/18 to $958.2 million, a new high.

Asset enhancement initiatives at VivoCity are a work-in-progress. MCT’s manager says AEIs, which were completed in July last year and cost $3 million, should contribute 29% in annual returns when stabilised. The REIT is adding a 32,000 sq ft public library on Level 3. Because of the library, bonus gross floor area is granted under the Community/Sports Facility Scheme. This bonus GFA will be used to extend Basement 1 by adding about 24,000 sq ft of retail space, to be completed in the middle of the current FY ending March 31, 2019. On a stabilised basis, this AEI is estimated to deliver 10% of annual return on investment based on estimated capital expenditure of $16 million.

Resilient suburban malls

FCT continues to grow its DPU. Its 2QFY2018 DPU rose 2% y-o-y to a new quarterly high of 3.1 cents. Revenue for 2QFY2018 (FCT has a September year-end) was up 6.3% y-o-y to $48.6 million and NPI was up 6.9% y-o-y to $34.8 million. Growth was driven mainly by a 31.7% y-oy revenue increase from Northpoint City North Wing (including contribution from Yishun 10 retail podium), as its occupancy rate improved significantly after the completion of an AEI.

Causeway Point, which accounts for 45% of FCT’s revenue, achieved a 1.3% y-o-y increase in revenue on higher rent revenue. The six months to March 31 average portfolio rental reversion stood at 3.9%.

FCT’s pipeline properties developed by sponsor Frasers Property include Nortpoint City South Wing, which was last valued at $1.16 billion, and a one-third stake in Waterway Point valued $1.148 billion. While Waterway Point appears to have stabilised, Northpoint City South Wing has just opened.

“Waterway Point is doing very well in Punggol, where there is a large residential catchment,” says Chew Tuan Chiong, CEO of FCT’s manager. “North Point City’s shopper traffic is among the top two to three for suburban malls in Singapore. Its business continues to be strong. With these two, we have an option [to acquire] when they become available for purchase.”

MCT and FCT have Singapore pipelines, with strong sponsors that will be supporting their growth should they acquire properties in the next 12 months. Their unit prices reflect their safe-haven characteristics, and they are trading above their book values (see table). Investors buying into these two REITs are buying into stable yield, tinged with growth that they would need to support.

The industrial REITs with pure Singapore exposure are relatively small in size, and could be the subject of mergers and acquisitions, given the maturity of the S-REIT sector.

FEHT has already made an acquisition that has yet to boost DPU. It is also trading at a low, and at a discount to its book value, but investors just do not seem to be excited about it.

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