• FTSE S-REIT Index gained +0.4% MTD and +21.7% YTD. Strongest gains were from the healthcare sub-sector (+3.9%) and weakest showing at the hospitality sub-sector (-2.3%).
• Performance in August: Best performer – Keppel-KBS US REIT (+5.7%), Worst performer – Eagle Hospitality Trust (-10.3%).
• Sector yield spread of 288bps over the benchmark 10-year SGS (10YSGS) yield was at the -1.3 standard deviation (SD) level.
• 3m SOR was flat at 1.75% at 16 August 2019 versus 1.76% at end-July.
• Remain NEUTRAL on S-REITs sector. Sub-sector preferences: Office and Hospitality.

SECTOR SNAPSHOT

S-REIT yield spread briefly crossed above the -1SD level before settling at 288bps (-1.3SD). The 10YRSGS yield fell 14bps MoM, to end at 1.80% while the FTSE S-REIT Index ended at 905.8pts after reaching the YTD-high of 941.7pts in early July.

3-month SOR was 1.75% as at 16 August 2019 from 1.76% at end-July.

Australia-listed Lendlease is planning to list a retail REIT. This will be the fourth REIT listing in Singapore this year. Lendlease is a developer-owner-operator of residential, commercial and retail assets.

The proposed merger of OUE Commercial Trust (OUECT) and OUE Hospitality Trust (OUEHT) was approved by shareholders at the respective EGMs held on 14 August 2019. 95.7% of OUECT shareholders 98.4% of OUEHT shareholders voted in favour of the merger. The expected delisting date of OUEHT units is slated for 30 September 2019.

Development plans for the Greater Southern Waterfront (GSW) will comprise 30km of coast line (20,000ha of land) and include 9,000 housing units (public and private). GSW plans include the development of office and recreational space. REITs that have assets in the vicinity include MapleTree Commercial Trust (VivoCity, MapleTree Business City I and PSA Building), Frasers Commercial Trust (Alexandra Point and Alexandra Technopark).

Outlook/Results update for the quarter ended 30 June 2019

Retail:

The retail sales index (RSI) was slightly negative, falling 0.8% YoY in June 2019 (Figure 4). The weaker retail sector outlook produced mixed results for the REITs under our coverage, with tenant sales falling 0.7% YoY for 1H19 for CMT (Neutral), while FCT (Accumulate) recorded a 2.9% growth YoY for the two months ended May 2019. Both REITs managed to achieve positive rental reversions of 1.8% (CMT) and 3.1% (FCT).

The retail rental index fell 1.5% QoQ as the rental growth in fringe assets were wiped out by falling central rents (Figure 5). We see a clear outperformance of fringe retail assets over their central counterparts, with median prices and rental showing growth for fringe assets while falling for central assets. We also note the narrowing of fringe and central prices and rents.

Office:

Office rents and occupancy continued to maintain their upward trajectory, with the rental index up 2.3pts QoQ in 2Q19 and occupancy increasing by 36bps QoQ to 88.5% in 2Q19. Central office median rents still healthy, registering a 3% rise YoY to S$102psm/mth, while fringe office median rents grew a modest 4.5% YoY to S$46psm/mth.

Average annual supply of office space coming onto the market from 2019 to 2023 (0.8mnsqft) is 27% less than the 10-year average supply of 1.1mn sqft and should help to support rents and deliverpositive rental reversions. The outlook is positive for CCT (Neutral), with passing rents for 2019 and 2020 on the downtrend, below the current average market rent.

Office transactions have still been buoyant with the property price index at a 22-year high (Figure 11), up 1.3pts QoQ in 2Q19, upheld largely by central office prices.

Industrial:

The industrial subsector recorded the highest growth in revenue, NPI and DPU. However, earnings growth was mainly acquisition driven.

Industrial rents and occupancy remained flat YoY in 2Q19. New supply of industrial space coming on to the market in FY19/20 represents 1.6%/3.6% of existing supply and is already 90%/39% pre-committed. This should provide industrial rents support amidst the softer economic outlook.

While the manufacturing outlook appears grim, we believe AREIT (Accumulate), with <10% of lease expiring in FY19 and its diversified tenant base of 1,350 tenants is largely protected.

Hospitality:

RevPAR across the Singapore hotels portfolio were slightly weaker in 2Q19, on lower average room rates and occupancy, due to the absence of the biennial events such as the Food & Hotel Asia. The global economic uncertainty has resulted in the tightening of corporate budgets, partially mitigated by the uptick in leisure travel which helped to make up for the weaker corporate demand. The increasing popularity of serviced residences (SRs) among leisure travellers, allows SRs to yield up on comparatively higher average room rates (ARRs) for shorter stays.

We note that hospitality REITs with overseas assets performed better. Pure-play Singapore hospitality REITs reported lower distributable income and DPU for 2Q19 and 1H19. The better performance is attributed to the diversification across geographies, where better performance due to event driven factors in certain geographies help to offset the strong competition in other markets.

REITs and trusts with assets in the UK enjoyed better performance (ART (Accumulate), CDLHT), supported by the sporting events and the weaker GBP. However, the more pronounced competition in China and Australia had made for a more challenging quarter for REITs with exposure to these geographies. Japan faces strong hospitality supply coming online, partially mitigated by a strong events calendar (Rugby World Cup in 2019 and the 2020 Olympics). This produced mixed results among REITs with assets in Japan, with ART, FHT and AHT (mainly acquisition driven) performing better than CDLHT.

The two newly listed US hospitality trusts, ARA US Trust and Eagle Hospitality Trust, reported results that beat their forecasted DPU by 3.2% and 1.2%. Forecast outperformance was due to better operational performance due to higher occupancy and improvement in RevPAR.

INVESTMENT ACTIONS

Remain NEUTRAL on the S-REITs sector

While the S-REIT yield spread is currently below the -1SD level since the global financial crisis, strong rental growth should offset any adverse effects from rising interest rates.

We maintain NEUTRAL on the S-REITs sector, with selective sub-sector preferences.

Top-down view (unchanged)

We like the Commercial and Hospitality sub-sectors due to tapering supply after the surge in supply in the prior two to three years. We are cautious on the Retail sub-sector as retail sales and shopper footfall both leave much to be desired.

Tactical bottom-up view (unchanged)

REITs that can better weather through the rising interest rate environment would be those with:

1) Low gearing; 2) High-interest coverage; 3) Long weighted average debt to maturity; and

4) A high proportion of debt on fixed interest rates