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Dovish-sounding Fed chair tempers rate rise expectations, boosting REITs as some sectors bottom out

Goola Warden
Goola Warden • 7 min read
Dovish-sounding Fed chair tempers rate rise expectations, boosting REITs as some sectors bottom out
SINGAPORE (Jan 14): First, a quick recap of 2018. The FTSE ST Real Estate Investment Trusts Index fell 9.3%, outperforming the FTSE ST Real Estate Index, which dived more than 16% last year. Top 2018 price performers were retail REITs CapitaLand Mall Trus
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SINGAPORE (Jan 14): First, a quick recap of 2018. The FTSE ST Real Estate Investment Trusts Index fell 9.3%, outperforming the FTSE ST Real Estate Index, which dived more than 16% last year. Top 2018 price performers were retail REITs CapitaLand Mall Trust or CMT (+6%) and Mapletree Commercial Trust or MCT (+2%). The worst performers were First REIT, which fell 29% and Lippo Malls Indonesia Retail Trust, which collapsed 55%.

This year, REITs could continue to be in demand. US Federal Reserve chairman -Jerome Powell, in his latest statement, implied that the Fed would be more flexible on monetary policy and was in no rush to raise interest rates. He cited that cross-currents had emerged since 4Q2018 and indicated the Fed would tweak its quantitative tightening programme, which currently allows US$50 billion ($67.7 billion) in government debt and mortgage bonds to come off its books each month.

“We don’t believe that our issuance is an important part of the story of the market turbulence that began in the fourth quarter of last year. But, I’ll say again, if we reached a different conclusion, we wouldn’t hesitate to make a change,” Powell said at the American Economic Association’s annual meeting on Jan 4. “If we came to the view that the balance sheet normalisation plan — or any other aspect of normalisation — was part of the problem, we wouldn’t hesitate to make a change.”

The Fed’s board members have lowered the median projection for GDP growth in 2019 to 2.3%, from 2.5%. They added in their policy statement that the Fed would monitor global economic and financial developments to assess their implications for the US’ economic outlook.

Analysts and economists are revising downwards their median projection for US fed funds rate hikes by 0.2 percentage point to 2.9%, implying two rate hikes instead of three for 2019, while some market watchers reckon the implied FFR could be even lower. “The market was pricing in an implied fed funds rate of 2.93% in early November, but this figure has since dropped to 2.39%, pointing to zero Fed hikes over the coming year,” says Eugene Leow, rates strategist at DBS Research, in a Jan 8 note. The market should price in one to two rate hikes again, he adds. “The key risk to our outlook is a marked deterioration in the US economy, prompting the Fed to reverse course in 2019.”

Local risk-free rates as defined by the yield on 10-year Singapore Government -Securities fell to a low of 2.05% on Jan 2 and 3, from a high of 2.68% in May 2018. -S-REIT yields are valued off 10-year SGS yields.

“The dovish tone is positive for REITs, as one of investors’ key concerns was a sharp spike in interest rates making REITs relatively unattractive. As such, investors’ continued appetite for yields and safe-haven instruments is clearly visible, with 10-year US and Singapore bond yields currently at 2.66% and 2.13% (as at Jan 4) respectively, down nearly 60bps from their 2018 peak,” says a Jan 8 RHB Securities report.

Interestingly, S-REITs offer the highest yields and highest yield spread (see Chart 2). They are now trading at an average 405bps yield spread to the 10-year bond yield (see Chart 3), RHB points out. The price-to-book ratio is at the average mean of 1. These valuations do not look stretched, as S-REITs tend to trade at a premium when the growth outlook is positive, RHB says.

Which REITs are best?

DBS Research has provided a property clock in its first REIT report of the year (see Chart 1). Industrial and retail are just past six o’clock. Office is at nine o’clock, on the border between a rising market and a peaking market. No surprise then, that among its five top picks, DBS has three retail-focused REITs. These are CMT, MCT and Mapletree North Asia Commercial Trust. (MNACT’s largest asset is the Festival Walk shopping mall in Hong Kong, which accounts for 63% of its asset size and net property income, or NPI.)

According to URA’s 3Q2018 statistics, supply of retail space is likely to have peaked at 204,000 sq m in 3Q2018, and to fall to 104,000 sq m this year. Retail space supply is likely to decline to just 62,000 sq m in 2020, and to 59,000 sq m in 2021. For 2019, the URA did not announce significant new retail space in its government land sales programme.

“With supply risk behind, we believe that the retail sector should improve visibility and operationally. Rental rates are starting to show signs of growth, after over a year of stabilisation,” says the DBS report. “We see moderating risks for the retail sector as a whole and expect rental reversions to bottom out in 2019,” it adds.

URA’s 3Q2018 figures show that rentals of retail space decreased by 1.2% during the quarter, compared with a decrease of 1.1% in the previous quarter. Signs are emerging that rentals may have troughed or are bottoming. For instance, SPH REIT reported strong rental reversions for its 1QFY2019 ended Nov 30, 2018. Paragon recorded a positive rental reversion of 10.1% for new and renewed leases representing 8.4% of the mall’s net lettable area for 1Q. SPH REIT’s overall portfolio — comprising Paragon and The Clementi Mall — registered a positive rental reversion of 9.7%. Tenant sales continued to register growth and 1QFY2019 visitor traffic was higher by 3.6% compared with 1QFY2018.

For its first quarter, SPH REIT announced a flat y-o-y distribution per unit of 1.34 cents. In December 2018, it acquired Figtree Grove Shopping Centre in Australia. Based on pro-forma data, DPU accretion from Figtree is around 0.36% (5.7% NPI yield, post-acquisition costs). A recent report by SooChow CSSD Capital Markets estimates that Figtree could contribute 3% to 4% to total revenue and NPI for FY2019. SooChow CCM has a “hold” rating on SPH REIT and prefers Frasers Centrepoint Trust, which owns defensive suburban malls and has an attractive pipeline property to acquire in the form of Waterway Point.

DBS says CMT’s suburban malls are likely to provide a resilient income base, while its acquisition of the 70% of Westgate it did not own in 2018 and the completion of Funan in 2QCY2019 are likely to lead to a 4% rise in DPU over the next three years.

For MCT, DBS says VivoCity and Mapletree Business City I are the best-in-class retail mall and business park in Singapore respectively and, as such, will be able to -attract tenants and drive rents.

Industrial supply peaks as rents trough

The bulk of industrial property supply that came on stream between 2014 and 2017 is tapering. Based on 3QCY2018 data from JTC, vacancy rates are marginally lower for all industrial property, at 10.9% for 3Q2018, compared with 11.3% in 2QFY2018 and 11.4% in 3Q2017. Vacancy rates for business parks stood at 14.5% for 3Q2018, versus 14% in 2Q2018 and 13.4% in 3Q2017.

The latest JTC statistics show that as at 3Q2018, a total of 4.8 million sq m, or 51.8 million sq ft, of new industrial space is either under construction or in planning and projected to be completed over the next five years, from 2018 to 2022, and beyond. Of this, more than 10% was completed by end-2018. “We expect a slight improvement [in vacancy rate] to 10.8% in 2018 and a more controlled vacancy rate in the upcoming years as supply starts tapering off,” DBS says.

Despite the improving fundamental outlook, there is a problem with industrial property in Singapore. Land tenure for industrial land is generally shorter than for other forms of commercial property. As a result, industrial REITs have to start depreciating their land values if there is less than 15 years of lease left. This can cause a -REIT’s net asset value to fall over time.

Within the industrial sector, RHB likes science and business parks, and logistics. Hence, its preferred stocks in the sector are Ascendas REIT and Cache Logistics Trust. Ascendas REIT has a diversified asset base with science and business parks comprising 35% by asset value, logistics and distribution centres 26%, and high-spec industrial and data centres 20%. Both Ascendas REIT and Cache have diversified to Australia for freehold properties with long weighted average lease to expiry (WALE) profiles, and Ascendas REIT acquired a portfolio of logistics assets in the UK in 2018.

DBS prefers Mapletree Logistics Trust and Frasers Logistics & Industrial Trust. MLT acquired $1.3 billion of properties in 2018, and these should contribute to DPU with the full benefit felt in FY2020 (MLT has a March year-end). FLT owns largely freehold property in Australia and Europe, with inbuilt rental escalation clauses and long WALE.

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