• Low inflation and tepid interest rate increases ensured that S-REITs continued their strong performance post-GFC. 2017 gains was 25.2% (inclusive of dividends) at end November, led by hospitality (29%) and office (23%) sectors.
• Market consensus now expects 3 interest rate hikes in 2018 and we believe further upward pressure on bond yields will come from intensifying Fed balance sheet tapering in 2018.
• Current sector yield spreads have dropped below post-GFC average. We maintain our Neutral rating.

2017 Review

S-REITs put in a strong performance in 2017, gaining 25.2% (inclusive of dividends) as at end November, led by hospitality (29%) and office (23%) sectors. Worries at the start of the year about more rapid interest rate increases by the Fed crimping the performance of REITs proved unfounded. Low inflation and tepid interest rate increases ensured that S-REITs’ strong performance post-GFC continued. Furthermore, the SGD strength kept SOR rise in check for large parts of the year (Figure 55), while the competitive banking landscape resulted in thinning bank spreads. These kept borrowing costs for REITs at depressed levels despite three Fed rate hikes in 2017.

Retail – Retail sales at malls continue to be sluggish (9M17 slightly negative to flat YoY), dragging down rental reversions to the near weakest levels post-GFC. Brick and mortar retail sales have generally not kept pace with the recovery in general retail sales index (9M17 +1.8% excl. Motor), suggesting some of the strength could be from non-brick and mortar related sales, e.g. petrol services, or online sales. Occupancy costs generally crept up with CMT (19%) and FCT (18%) looking at record high occupancy costs.

Office – Peak supply in 2017 was the primary concern at the start of 2017, but we are experiencing a gradual absorption. Marina One pre-committed occupancy 70+%. As new supply was taken up, Grade A office rents have stabilised and rebounded in 3Q17 after falling 17% in nine consecutive quarters since 1Q15. 2017 also saw a record land price bid by Guocoland at S$1706/psf for Beach Road GLS commercial site.

Hospitality – YTD17 saw tourist arrivals increase c.4%, much weaker than 2016’s 7.7%. Despite slower growth YoY vs 2016 (c.7.7%), hotel RevPAR managed to stabilise and clocked in four consecutive months of growth in September after 13 quarters of decline (Figure 60). Industry RevPAR at $215 is almost two-year highs.

Outlook

Inflation and interest rate hikes remain our key concerns for 2018. Market consensus now expects 2-3 interest rate hikes in 2018 and we believe further upward pressure on bond yields will come from intensifying Fed balance sheet tapering in 2018. As such, we remain cautious on the sector with a NEUTRAL rating. Sector yield spreads have dropped below post-GFC average (Figure 56). We remain selectively optimistic on the hospitality sector as we expect continued RevPAR strength on the back of various drivers elaborated below.

Retail (Neutral) – Operating environment in malls to remain challenging as we expect Amazon and other e-commerce players to continue gaining popularity and acceptance, despite the possibility of an online sales tax which could level the playing field between online and offline retailers. The potential increase in GST as mooted by the government, if materialised, will be add a further headwind and dent consumption. High occupancy costs will impede landlords’ ability to raise rents. We expect retail rents to bottom only by 1H18 (Figure 57).

Office (Neutral) – Supply of Grade A office space will taper off sharply after 2017, with an expected c.800k sqft coming on in 2018, lower than average net annual demand of 1170k sqft post-GFC. Along with improved demand for office space driven by recovering global economies, we expect continued strength in office rents. We expect Grade A office rents to grow 5-7% in 2018 (Figure 58).

Hospitality (Overweight) – New room supply growth will wind down after 2017 with a 1.7% increase forecasted for 2018. We expect 2018 RevPAR to continue to improve because of 1) STB’s continued push to boost tourism in Singapore; 2) Return of biennial events in 2018 such as the Singapore Air Show; 3) Tapering hotel supply.