• FTSE S-REIT Index underperformed the STI and Real Estate Developer Index. Hospitality segment was the best performer, up 16.0%, lifted by news of vaccine progress. Industrial segment fared the worst, down 2.2%.
• Sector yield spread of 338bps over the benchmark 10-year SGS (10YSGS) was -0.1SD.
• Remain OVERWEIGHT on SREITs with catalysts expected from acquisitions fuelled by the conducive interest rate environment. Sub-sector preferences are hospitality (upgraded), office and industrial. Top picks are Manulife US REIT (MUST SP, Buy, TP: US$0.92), Frasers Centrepoint Trust (FCT SP, BUY, TP: S$2.79) and Ascendas REIT (AREIT SP, BUY, S$3.61).

SECTOR SNAPSHOT

Acquisition momentum continued, with Ascendas REIT, CapitaLand Retail China Trust, Mapletree Logistics Trust, Suntec REIT and ARA LOGOS Logistics Trust announcing acquisitions in the last one month.  

Leasing remained challenging across the sectors as companies held off expansion and relocation. Renewals are expected to form the bulk of leases as businesses try to preserve capital and save on relocation.

Office:

Several banks have allowed their staff to telecommute 40-60% of the time. DBS’ 29,000-strong workforce has the option to work remotely up to 40% of the time while 65% of UOB’s 26,000-strong workforce has the option to work remotely two days a week. As financial institutions are the top three occupiers of office space, we think this move towards flexible work arrangements will set in motion more aggressive rightsizing of space in the mid-term.

REITS have reported a handful of pre-terminations, with tenants giving back 10-20% of their space. Encouragingly, part of the space vacated has been backfilled. QBE Insurance is relocating to Guoco Tower and taking up 31,000 sq ft of space vacated by Grab, which is moving to one-north. Amazon will lease 90,000 sq ft across three floors at Asia Square Tower 1 given up by Citigroup.

Industrial:

Industrial rents dipped 0.7-1.1% QoQ across the asset classes while occupancy inched up 0.2ppt, lifted by factories (+0.2ppt) and business parks (+0.7ppt).

Mixed outlook. Logistics assets have benefited from expansion by e-commerce and third-party logistics players while demand for business parks has come from firms relocating to business parks with similar specifications as Grade A offices to save costs. A continued moratorium on data centres is expected to lead to higher rents in the coming years. Leasing of factory space may not fare as well as the global demand recovery is nascent while demand for hi-tech space remains supported by growth in electronics demand.

Retail:

Retail occupancy was steady QoQ at 90.4%, although rent weakness was detectable. Central rents tumbled by 6.4% QoQ and 10.2% YoY while fringe rents dipped 1.4% QoQ and 4.4% YoY. This is likely to continue as retail landlords prioritise occupancy over rents and exercise flexibility in lease negotiations.

The pandemic was the final nail in the coffin for ailing concepts such as department stores. In October, Robinsons announced the closure of its Singapore stores for good. It followed Top Shop’s decision to pull out of Singapore in September. News of multinational fast-fashion chains such as H&M, Gap and Forever 21 slashing their global store counts is worrying and will likely impinge on demand for retail space.

Hospitality:

RevPARs have been climbing since hoteliers were able to accept staycation bookings in July. Industry occupancy remained above 60% in 3Q20, recovering from its low of 40% in March and April. Hotels that are expected to draw staycation demand are luxury/upscale or resort-styled accommodations. With bans on leisure travel likely to remain in place towards the festive season, hoteliers are anticipating a spike in staycation demand. They have raised room rates by S$100-200.

Meanwhile, hospitality players have achieved leaner cost and operating structures through the adoption of digital technology. They have lowered manpower costs by enabling self-check-in using mobile devises and turning to service robots and mobile applications for reservation systems.  

INVESTMENT ACTIONS

Maintain OVERWEIGHT on sector

Broadening economic recovery

Since June, economic indicators have been improving. These include manufacturing output, NODX and retail sales. SREITs share that most of their tenants remain current with their rents, although a handful are still in need of rental assistance. News of high success rates of the Pfizer and Moderna vaccines has lifted sentiment, potentially benefitting hospitality REITs the most.

Sub-sector preferences: hospitality, office and industrial

almost a year of living under travel and mobility restrictions, demand for travel is expected to pent up. With many countries rushing to secure more than one vaccine, high participation in the COVAX* programme and months of calibrating the manufacturing and distribution of vaccines, we think this last leg of the vaccine timeline will be swifter. As we believe it pays to be early in our call, we have upgraded the hospitality sub-sector to overweight.

We like US office REITs for their long WALEs and downside protection from remote-working adoption. Our stock picks are Manulife US REIT (MUST SP, Buy, TP: US$0.92) and Prime US REIT (PRIME SP, Buy, TP: US$0.94).

Our pick for retail exposure is Frasers Centrepoint Trust (FCT SP, BUY, TP: S$2.79). Tenant sales at its suburban malls have recovered to pre-COVID levels. We believe that suburban malls will remain an important infrastructure, catering to necessity spending.

MACROECONOMIC ENVIRONMENT

OFFICE

As more workers return to the office, companies are able to evaluate their space needs. Several banks have announced flexible working arrangements, allowing their workforce to telecommute 40-60% of the time. DBS’ 29,000-strong workforce has the option to work remotely up to 40% of the time. About 65% of UOB’s 26,000-strong workforce has the option to work remotely two days a week. Financial institutions are the top three occupiers of office space and we think their move towards flexible work arrangements will set in motion more aggressive rightsizing of space in the mid-term.

REITS have reported a handful of pre-terminations, with tenants giving back 10-20% of their space. Encouragingly, part of the space vacated has been backfilled. QBE Insurance is relocating to Guoco Tower and taking up 31,000 sq ft of space vacated by Grab, which is moving to one-north. Amazon will lease 90,000 sq ft across three floors at Asia Square Tower 1 given up by Citigroup.

Construction slippages (Figure 10), as well as muted supply in the market, are expected to provide near-term support for the office sector. Supply in the core CBD is at its 5-year historical average of 0.9mn sq ft in comparison to 1.2mn sq ft during the GFC (Figure 8). So far, two CBD commercial owners are revaluating redevelopments to unlock additional GFA from the CDB and Strategic Development Incentive Schemes. About 700,000 sq ft from AXA Tower (50:50 JV between Perennial and Alibaba) and CDL’s 353,575 sq ft Fuji Xerox Tower and 131K sq ft Central Mall will potentially be displaced in 2021/22, if plans for redevelopment proceed. 

INDUSTRIAL

Industrial rents dipped 0.7-1.1% QoQ across the asset classes while occupancy inched up 0.2ppt, lifted by factories (+0.2ppt) and business parks (+0.7ppt).

Mixed outlook. Logistics assets have benefited from expansion by e-commerce and third-party logistics players while demand for business parks has come from firms relocating to business parks with similar specs as Grade A offices to save costs. The moratorium on data centres remains firmly in place. This is expected to lead to higher rents in the coming years. Leasing of factory space may still be muted as global demand is only starting to recover. Demand for hi-tech space remains supported by growth in electronics demand.

RETAIL

Retail occupancy was steady QoQ at 90.4% although rents showed weakness. Central rents tumbled by 6.4% QoQ and 10.2% YoY while fringe rents dipped 1.4% QoQ and 4.4% YoY. This is expected to continue as retail landlords prioritise occupancy over rents and exercise flexibility in lease negotiations. Landlords have offered shorter leases of six months to tenants who are still struggling. They are also offering 3-year leases with lower base rents and higher turnover rents in the first year, with the base rents escalating over the years. Such leases are expected to lower occupancy costs for tenants in the short term as the economy recovers.

The retail sales index (ex-motor vehicles) dipped 4.4ppts MoM from -8.3% to -12.7% in September. Online retail sales made up 11% of the sales. Supermarkets (+18.9%), Furniture & Household Equipment (+11.0%) and Recreational Goods (+6.1%) continued to grow YoY while other fashion-related discretionary trades contracted 15.9-37.9%.

The pandemic was the final nail in the coffin for ailing concepts such as department stores. In October, Robinsons announced its total exit from Singapore for good. It followed Top Shop’s decision to pull out of Singapore in September. In light of the weaker leasing demand, REITs are evaluating their asset-enhancement initiatives and repositioning of their malls.

Singapore may enter Phase 3 of reopening before the end of the year. Phase 3 will entail a further relaxation of control measures. The cap on group gatherings may be increased from five to eight people. Restrictions on nightlife hotspots, which are deemed higher-risk, such as bars, karaoke lounges and nightclubs are likely to remain. Retail landlords will likely provide some rental support for tenants which continue to operate under restrictions.

HOSPITALITY

RevPARs have been climbing since hoteliers started to accept staycation bookings in July. Industry occupancy remained above 60% in 3Q20, recovering from its low of 40% in March and April. Hotels that are expected to draw staycation demand are luxury/upscale or resort-styled accommodations. With bans on leisure travel likely to remain in place as we enter the festive season, hoteliers are anticipating a spike in staycation demand. They have raised room rates by S$100-200.

China’s domestic air travel has recovered to pre-pandemic levels although international travel remains curtailed. Given that China is ahead in the COVID-19 timeline, we look at its recovery as a gauge for the other countries. Countries with sizeable domestic travel markets such as France, Japan, the US, Spain, India and Brazil could potentially see a similar recovery in domestic travel. Several vaccines have achieved success rates of over 90%. But for travel confidence to return, the vaccines must be available to all.

Meanwhile, cost initiatives by hoteliers have borne fruit. Cost and operating structures have become leaner through the adoption of digital technology. Hotels have lowered their manpower costs by enabling self-check-in using mobile devises and deploying service robots and mobile applications for reservations.   

Figure 25: COVID-19’s impact on DPUs and asset valuations

Figure 26: S-REIT Universe

*Note: Coloured columns indicate the critical attributes of REITs that should be looked at from a capital management perspective. Our colour coding represents the scale of the figure for each column, green representing better than average and red representing worse than average.