The second wave of Covid-19 cases brought on two additional rounds of fiscal stimulus in the form of the Resilience Budget (26 March) and Solidarity Budget (6 April) as well as a series stricter measures to further minimise the spread of the virus. With effect from 26 March, there is a mandated closure of bars, entertainment venues and enrichment centres. The safe distancing measures and the one person per 16sqm of space guideline reduced the operating capacity within venues, putting additional pressure on retail malls. The “circuit breaker” announced on 3 April will see the closure of school and workplaces, and suspension of business that cannot be conducted through telecommuting – except for essential services and key economic sectors – from 7 April to 4 May 2020.
The Covid-19 (Temporary Measures) Bill was proposed by the Ministry of Law on 1 April to provide temporary relief for the inability to perform contractual obligations. This includes leases for non-residential and will prevent the contracting party from taking legal actions against or terminating the lease of the non-performing party. If passed, the measures will be in place for 6 months from the commencement of the Act and may be extended for up to 12 months.
Meanwhile, the REIT Association of Singapore (REITAS) has written an open letter to regulators to outline the jeopardising position of the REITs from the impending Covid-19 Bill. The letter requests the government to offer mechanisms to shelter REITS from the impact of the rental deferment, such as underwritten financial support proportional to the deferred rental income.
We expect the retail sector to be the greatest casualty of the containment measures and Covid-19 Bill. Retail and F&B tenants have been actively engaging landlords for assistance and rebates. Excluding the F&B tenants within their portfolios, Commercial and Industrial landlords have not received many requests for assistance from tenants.
Due to the 90% payout requirement to qualify for tax transparency, REITs will face cashflow mismatch during this 6 to 12-month rental deferment period. While REITs can dip into their retained earning and capital gain reserves to shore up DPU. REITs are not averse to DPU cuts in the name of preserving capital and protecting their balance sheets – we expect the latter to be more of the case.
Following the 150bps cut in the FED rate, the 3M SOR fell 95bps YoY to 0.95%. While reference interest rates have fallen, credit spreads have increased due to the increase business uncertainty. REITS should not face any difficulty refinancing maturing loans, however whether there will be interest savings on renewal depends on the new credit spreads offered – as long as spreads do not wipe out the decrease in reference rates.
Caution and lower valuations putting a damper on future REIT acquisitions momentum, which have typically been structured using a mix of debt and equity capital. We expect acquisitions to pause, likely resuming in late 2020. Accretive acquisitions are still possible especially for REITs with lower gearings and higher debt headroom which are trading at above-par P/NAV. The pipeline of IPOs that were speculated to come onto the market – CDL’s UK office REIT and SPH’s student accommodation REIT – will see their timelines pushed back until the market stabilises.
Tikehau Capital (TC) and City Developments Limited (CDL) jointly increase stake in IREIT Global REIT from 16.6% to 29.2% and 12.5% to 20.9% respectively. Together, TC and CDL now own more than half of IREIT. TC and CDL each own 50% stake in the manager of IREIT, IGG.
Ascendas REIT acquired a 25% stake in Galaxis, a 99.6% occupied business park located in One-North, for S$102.9mn, 3.1% lower than the independent market valuation of the property. At an NPI yield of 6.2%, the acquisition is expected to improve proforma DPU by 0.013 to 0.11 cents.
The RSI (excl MV) fell by 11.7% in February, dragged down by Fashion (-37.5% YoY) and the F&B index (-14.7% YoY) which make up the bulk of mall tenants. On top of the 100% property tax rebates which will come up to approximately 1 month’s rent, CMT and FCT will be giving an additional c.1 month rental rebate to their tenants. The impact of the impending Covid-19 Bill will be more difficult to quantify, which will result in a 6 to 12-month rental deferment period for landlords and higher bad debt risks – should tenants go under during this period. We expect suburban malls to perform better than central malls during the circuit breaker period where most residents will be working from home due to workplace closures. This may boost the takeaway/delivery F&B and grocery spending in the suburban malls, which are household catchments. Shorter lease terms and mildly negative rental reversions on leases expiring in 2020/21 likely as landlords exercise flexibility in order to help tenants pull through and maintain occupancy levels.
Preliminary international visitor arrivals are estimated at -90% YoY for the month of March. Hotel occupancy was supplemented by returning residents who choose to serve their 14-day stay home notice period in hotels. Accommodations which have a higher exposure to longer-staying corporate clientele such as service residence (SRs) experienced stable occupancy of c.60% and will hold up better against their hotel peers, which saw occupancy levels ranging 30% to 70%. Some hospitality REITs are exploring the possibility of accelerating their AEI and repair and maintenance timelines to coincide with the lull period, thereby future-proofing their portfolios and commanding better room rates in time for the pickup post-Covid-19. It is worth noting that most SG-listed hospitality REITs (except ARA US) have revenue structures with at least 50% of revenue form “stable” sources, either through assets that are leased out on master leases, or though leases with minimum base rent provisions.
Containment measure have pushed businesses to implement business continuity plans and telecommuting. The successful implementation of remote working will cause companies to re-think their space requirements and may accelerate the technology-enabled structural change in demand for office space. Although commercial supply is benign in the coming years, rightsizing of space will threaten occupancy and may put downward pressure on rents.
Possibly the only beneficiaries of the Covid-19 outbreak, the importance of ecommerce and cloud storage as trends of the future reiterated the demand for logistic assets and data centres. Meanwhile, factory and light industrial assets that have their supply chains affected and largely occupied by SMEs may come under pressure.
Upgrade SREIT sector to OVERWEIGHT, sub-sector preference: Office and Industrial.
While it is difficult to ascertain if valuations have bottomed, we believe that the sharp decline in share prices (FTSE REIT Index -29.4%) presents an attractive entry. Figure 4 shows the historical sector P/NAVS – hospitality and retail sectors trading at 0.45x and 0.66x respectively, in comparison to their post-GFC (normalized) P/NAVS of 0.95x and 0.98x. However, we note that this is still 35.6% and 40.9% higher than the troughs seen during the GFC (0.27x and 0.39x). Figures 5 to 15 show the historical P/NAVs of the REITs under our coverage to visualise current P/NAVs compared to historical troughs.
Containment measures and telecommuting have reiterated the importance of major trends of the future – technology and ecommerce – which will set into motion structural shifts in the real estate sector. Logistics and data centres will receive renewed interest while commercial REITs will likely see some right-sizing within their portfolios.
We prefer FCT, AREIT and ART as we believe their strong fundamentals and characteristics will help them ride out this period of uncertainty better than others. While the long-term drivers remain intact for the aforementioned counters, near term earnings will be impacted by the containment measures and impending Covid-19 Bill, warranting a review of our target prices.
Sub-urban mall owner FCT will be protected by necessity spending, which accounts for c.59% and c.52% of net leasable area and gross rental income respectively (using the government’s definition of essential services which includes F&B). In addition, the long term (inorganic) growth drivers for FCT remain intact. AREIT’s diversified tenant base and ART’s 50/50 growth/stable* leases structure and geographical diversification will reduce concentration risk and exposure to a particular industry or geography, providing stable earnings. We are cautious that the prices may continue falling in the near-term – but this presents opportunities to average down entry prices.
Top-down view (unchanged)
We like the Commercial and Industrial sub-sectors due to tapering commercial supply after the surge in supply in the prior two to three year, and the AEI and redevelopment opportunities for the Industrial sector. We are cautious on the Hospitality and Retail sub-sector due softer tourism sentiment and retail outlook, exacerbated by the fluid Covid-19 situation.
Tactical bottom-up view (unchanged)
REITs that can better weather through this period of uncertainty 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; 5) Higher percentage of guaranteed revenue through “fixed” or “stable*” leases.
*Stable leases are leases under master lease or with minimum base rent provisions