• Maintain Equal Weight view on Industrial REITs sub-sector.
• Sector occupancy and Rental Index still searching for a bottom.
• Oversupply situation abating, and we believe rents to bottom by end-2018.
• Occupancy has not picked up, despite higher industrial activity.
• We want to see occupancy improve, in order to upgrade our sector view.
• Only A-REIT has not achieved our target price, and remains as our top pick.

What is the news?

• JTC recently released its Quarterly Market Report of Industrial Properties for 3Q 2017.

Key takeaways from the quarter

• Improved sentiment on the ground, but not a walk in the park

Similar to the previous quarter, managers generally gave feedback that they are seeing more enquires compared to a year ago. However, it is still taking time for enquiries to convert into actual transactions. Managers are still actively engaging tenants to maintain occupancy and it is a tenants market. Demand is coming from trade sectors such as precision engineering, cyber-security, software and bio-medical devices.

• Outlook for negative reversions to persist into 2018

In this quarter, rental reversions were still skewed negatively and ranged between -21% (AIMS AMP Capital Industrial REIT (AA-REIT)) and +3.1% (Ascendas REIT (A-REIT), Singapore portfolio). Mapletree Industrial Trust managed +2.8% on renewals. With the improved sentiment on the ground, managers are paying attention to absorption of supply in 2018. Our view for negative reversions to persist in the near-term remains unchanged from previous quarter, and we believe rents to bottom only by the end of 2018.

• Tenant defaults likely to impact specific property valuations

With multiple tenant defaults, we think that Sabana Shari’ah Compliant REIT (SSREIT) and Soildbuild Business Space REIT (SBREIT) would be most at risk in terms of downward portfolio revaluations at the end of the year.

The master tenants at 1 Tuas Avenue 4 and 6 Woodlands Loop in the SSREIT portfolio have defaulted on rent payment. The property values of these two properties will likely be negatively impacted by the impaired income visibility.

Over at SBREIT, the tenant at 2 Pioneer Sector 1 (NK Ingredients) had defaulted and is no longer able to furnish an insurance guarantee, while the tenant at 61 & 71 Tuas Bay Drive (KTL Offshore) is currently in arrears. These are the two sources of downside risk for portfolio value.

• Higher level of capital raising activity
  • Cache Logistics Trust (Cache) had an 18-for-100 Rights Issue, raising S$102.7 mn to pare down aggregate leverage from 43.4% to 35.5%. While financial standing was improved, dilutive impact was immediate in 3Q 2017 DPU.
  • Mapletree Logistics Trust (MLT) raised S$353.5 mn from a Private Placement and S$286.5mn from a 1-for-10 Preferential Offering to partially fund the acquisition of Mapletree Logistics Hub Tsing Yi in Hong Kong for HK$4.8 bn (S$834.8 mn) from its Sponsor. MLT’s portfolio has been boosted to S$5.36 bn.
  • Mapletree Industrial Trust (MINT) announced a Private Placement which raised S$155.7 mn. This was to partially fund the acquisition of a platform of 14 data centres in the USA through a JV with its Sponsor.

ESR-REIT raised S$150 mn in 4.6% perpetual securities to fund the acquisition of 8 Tuas South Lane. It was a sale and leaseback transaction with Hyflux.

Investment Actions

We maintain our “Equal Weight” view on the Industrial sub-sector.

The tailwinds for the sector are the tapering of supply of Industrial space in 2018 and industrial activity for 9M 2017 has been robust. However, occupancy is lower QoQ and YoY in 3Q 2017. The uncertainty is the exact timing of the bottom for rents, but we believe it to be by end-2018. Negative reversions also likely to persist into 2018.

We would like to see sector occupancy to improve, in order to upgrade our sector view for Industrial REITs.

Strategic top-down view (unchanged from previous quarter)

• Maintain exposure to Business & Science Park properties and Hi-Tech/Hi-Specification buildings

Singapore is evolving towards higher value-added manufacturing and there is a push with the Smart Nation initiative. We like REITs that can capture this opportunity with Business & Science Park properties and Hi-Tech/Hi-Specification buildings.

Key points for the REITs under our coverage

During the recent quarterly reporting cycle, we downgraded MINT to Neutral, as we believe the positive catalysts have been priced in. A-REIT remains our top pick. Despite being Neutral on Keppel DC REIT (KDCREIT) and MINT, we still like them for their portfolio composition exposed to segments with better demand prospects such as Hi-Tech Buildings and data centres. Moreover, both KDCREIT and MINT have relatively low gearing ~30% which affords ample debt headroom for inorganic growth.

Ascendas REIT – The stable giant

• Operationally, portfolio occupancy remains high at 92.0% with healthy WALE of 4.2 years.
• Diversified portfolio with right of first refusal (ROFR) to Sponsor’s pipeline of over S$1 bn of Business & Science Park properties in Singapore.
• 57% of A-REIT’s Net property income is derived from Business Park and Hi-Specs properties in Singapore.
• 33.1% gearing, which is lower than the sector median of 36.0%, affords ~$1 bn of headroom to acquire and grow inorganically.

Mapletree Industrial Trust – Hi-Tech and beyond by including overseas data centres

• We downgraded MINT to Neutral this quarter because our target price was achieved and we believe catalysts have been priced-in.
• Price-to-NAV now of 1.39x is more than 2 standard deviations from the mean, suggesting higher probability of disappointment at current level.
• Recently expanded Investment Strategy to include overseas data centres, capped at 10% by portfolio value. Shortly after, incorporated a 60:40 JV between itself and its Sponsor; to acquire a platform of 14 data centres in the USA for US$750 mn at ~7% NPI yield.
• Outlook for inorganic growth: Aggregate leverage of 30.0% is among the lowest in the S-REITs universe, giving it the firepower to make acquisitions.
• Outlook for organic growth: 14-storey Hi-Tech Building at Kallang (completion: 1Q 2018) and six-storey data centre in the West Region of Singapore (completion: 2H 2018) are coming online.

Keppel DC REIT – Specific exposure to a unique asset class

• Organically, long WALE of 9.2 years with <10% of leases by NLA expiring within the next three years provides medium-term income visibility.
• Gearing remains low at 32.1%, with ample debt headroom to grow the portfolio.
• At 1.48x Price-to-NAV, it could be an opportune time to raise new equity with the next acquisition.
• At this juncture, we highlight a misconception of comparing KDCREIT’s valuation with globally-listed data centre REITs.
  • As discussed in our initiation report (8 January 2016), KDCREIT is not comparable with US-listed data centre REITs on a price-to-NAV basis, because of the difference in accounting treatment of the data centres.
  • KDCREIT’s data centres are classified as Investment Properties on the balance sheet and revalued annually to market value.
  • US-listed data centre REITs classify their data centres as Property, Plant and Equipment and are held at historical cost and depreciated annually.
  • This difference in accounting treatment is the reason US-listed data centre REITs are able to trade at much higher multiples than KDCREIT. Consequently, we argue that it is not justified for KDCREIT’s price-to-NAV multiple to trade upwards to be on par with the US-listed data centre REITs.
  • We have two samples of annual reports, showing that the data centre properties of US-listed REITs are held at cost, less accumulated depreciation.

Figure 2: Extract from Equinix Inc, 2016 Annual Report

Source: Equinix Inc, 2016 Annual Report

Figure 3: Extract from QTS Realty Trust Inc, 2016 Annual Report

Source: QTS Realty Trust Inc, 2016 Annual Report

Cache Logistics Trust – Ready for the next lap

• Recent Rights Issue has brought gearing down to 35.7% from 43.4%; now in a better position to make acquisitions.
• Dispute with Schenker at 51 Alps Avenue has been amicably resolved, with rental topped-up to market rate resulting in no adverse impact to unitholders.
• Key downside risk is the master lease expiry of CWT Commodity Hub (27% by portfolio value as at FY16) in 2018, with an oversupply in the market.

Soilbuild Business Space REIT – Tenant default woes

• Multiple tenant defaults hitting the portfolio.
• Back-filling of 72 Loyang Way remains challenging.
• NK Ingredients (tenant at 2 Pioneer Sector 1) defaulted on rent and Trustee has called on the insurance guarantee. The tenant has been unable to top up and furnish an insurance guarantee, so it is likely for the lease to be terminated early. Thus affecting income visibility from 1Q 2018 onwards.
• KTL Offshore defaulted on rent. Its parent company, KTL Global Limited was flagged by its Independent Auditor, doubting the Group’s ability to continue as a going concern. More recently, the Group is also reshuffling its top management.
• Key downside risk to portfolio income is the ability find a replacement tenant at 2 Pioneer Sector 1, and ability of KTL Offshore to keep up with rent payments.