The market rally since the darkest days of the global financial crisis has gone on for much longer than many investors expected. At 3,229 now, the Straits Times Index (STI) is fast closing in on its all-time high of 3,831, set in October 2007. One way to ratchet down the risk profile of your investment portfolio is to hunt for promising real estate investment trusts (REITs).
Offering a risk-return balance between bonds and equities, these high-dividend-yielding instruments have proven to be reliable investments. In the past 12 months, the FTSE REIT Index rose 11.6%, almost matching the STI’s 11.7% gain. But that’s before dividends. Including their substantial distributions per unit (DPUs), REITs actually returned an average of 18% over the last 12 months, pipping the STI’s with-dividend return of 14%.
More importantly, there was apparently very little downside with the REITs. The two worst-performing REITs in the past year, Ascendas India Trust and CapitaRetail China Trust, still managed to return 7.2% and 3.6% respectively, including dividends. Meanwhile, CapitaCommercial Trust (CCT) and Parkway Life REIT, the two best performers, returned 41% and 37% respectively, easily matching many of the best STI stocks.
Then, there is the low interest rate environment. Not only is that spurring investors to hunt for yield with instruments such as REITs, it has also enabled the REITs to cut their financing costs. “Given the current low interest rate environment, S-REITs have taken the opportunity to refinance, lengthen their debt-maturity profile as well as widen their sources of debt, hence enjoying savings in interest,” brokerage firm DBS Vickers said in a recent report.
Yet, the risks are slowly mounting for the REIT sector too. Notably, the 10-year Singapore government bond yield, the benchmark for REIT yields, has been rising steadily. It is now hovering at 2.7% versus 1.9% in November. The five-year Singapore government bond yield has climbed even more sharply, to 1.36% from 0.86% in November and just 0.63% in October.
Christopher Gee, head of equity research at JP Morgan Singapore, says that makes this a potentially perilous time for REIT investors. “The danger is there,” he said. “Interest rates will go up at some stage. All REITs are interest-rate sensitive. Generally, REITs don’t respond well to an interest-rate rise.” In fact, Gee isn’t that keen on most of the property sector at the moment. “The big macro picture is too hard to call,” he said. “We are not in favour of developers and I’m not that keen on REITs either.”
Indeed, much like stocks, REITs aren’t particularly cheap at this stage. “REITs are trading slightly above their historical mean price-to-book value (P/BV),” said CIMB Research in a recent note. The key for investors now is to evaluate REITs carefully and be mindful of the risks.
One risk analysts see is acquisitions. While it is a means for REITs to expand their portfolios and cash flows, much depends on whether the deals are priced at terms that enable them to immediately increase their DPUs. But that is sometimes only achieved with a degree of financial engineering. For instance, the acquisition of one-third stakes in Marina Bay Financial Centre (MBFC) Phase 1 by K-REIT Asia and Suntec REIT were yield-accretive only because of “income support” from their parents for five years.
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While REITs are still less risky than stocks, investors ought to take a bottom-up approach in making their picks now, analysts said. JP Morgan’s Gee said performance in the property sector in 2011 is likely to be driven by specific micro-level dynamics more than anything else. In the REIT space, his preferences for this year are the smaller REITs that are able to generate growth and give a decent yield.
Sizing up the REITs
There are currently 24 REITs listed in the Singapore market. Their assets are spread across shopping malls, offices, hotels, factories and warehouses. There are even two that own healthcare-related properties such as hospitals. Their yields range from 4.9% for CapitaMall Trust (CMT) to more than 9% for some of the smaller industrial property trusts. The size of their portfolios varies too, from S$8.1 billion (RM19.2 billion) for CMT to just S$359 million for First REIT.
Besides acquisitions, the key method by which REITs improve their cash flows and DPUs is through asset enhancement. That includes the refurbishment of their properties to garner higher rentals as well as the expansion of the lettable area of their buildings. Reflecting the scale of its portfolio perhaps, CMT has a string of asset enhancement programmes underway.
For instance, its Jurong Entertainment Centre has essentially been torn down and is being rebuilt into a new mall called JCube, which will include an Olympic-sized ice-skating rink. It is scheduled for completion in early 2012. CMT will also begin enhancement works on its Atrium@Orchard in 1Q2011, which will see the expansion of its gross floor area and a significant enlargement of its retail space. Among CMT’s other key assets is a major stake in Raffles City, atop the City Hall MRT station. Its most recent acquisition was Clarke Quay, a clutch of touristy bars and food joints on the banks of the Singapore River.
CMT is among the REITs that analysts see benefiting from surging tourist arrivals in Singapore. “Tourism numbers are at record levels of nearly 12 million for 2010,” noted a CLSA strategy report dated Jan 3. “The expected continued increase in tourist arrivals in 2011 and beyond makes this the most significant, yet underappreciated, theme, in our view.” Based on CLSA estimates, tourism receipts hit a new high of S$18 billion last year. The tourism sector will be one of the key drivers for the Singapore economy in the next five years, according to the report.
“We forecast tourism receipts to realise a 20% [compound annual growth rate] over the next five years to reach S$37 billion by 2015, with the sector contributing 5.4% to our 2015 GDP estimate, well above the current 2.7%,” CLSA stated. It also believes that the official forecast for tourist arrivals of 17 million by 2015 and tourist receipt target of S$30 million will be surpassed. CLSA forecasts visitor arrivals of 18.5 million and tourism receipts of S$37 billion by 2015.
The biggest beneficiaries are likely to include the local retail sector and retail property owners such as CMT, according to CLSA. The REIT has a reasonable debt-to-asset gearing of 36%, and CLSA sees its book value gradually rising through revaluation gains. CLSA has a “buy” recommendation on CMT, with a price target of S$2.25.
JP Morgan’s Gee also has an “outperform” call on CMT, but he prefers Frasers Centrepoint Trust (FCT), which is linked to the Fraser & Neave group. “The basic non-discretionary consumer spending story will continue to do well,” he said. “FCT is lower-risk, and has been left behind by the larger-caps. The REIT’s four malls are located in suburban neighbourhoods. It is currently trading at a yield of 5.4% versus CMT’s 4.6%.
Perhaps the most direct tourism play in the REIT sector is CDL Hospitality Trusts, which owns 12 hotels and a shopping arcade. “We are only starting to see improvement in revpar (revenue per available room) and room rates. These have not been fully reflected in the stock,” Gee said. “Occupancy rates have been very good and hoteliers have significant pricing power.” OSK-DMG says CDL Hospitality Trusts is “well-positioned to ride the multi-year tourism boom”. Its debt-to-asset ratio is particularly low at 21% currently. If it were prepared to take that gearing level up to 45%, it would have room to raise its debt level from S$250 million currently to some S$800 million. It is currently trading at a forecast yield of 5.2%.
Upturn in office sector
OSK-DMG also likes Suntec REIT for its “foothold in the iconic Marina Bay corridor and favourable valuations”. After the MBFC acquisition, 30% of its net property income (NPI) will be from Grade A space through its one-third stakes in One Raffles Quay and MBFC Phase 1. A further 59% of its NPI comes from Suntec City, which includes retail space and Grade A offices.
According to DTZ Research, the pace of office rental growth gathered momentum in 4Q2010. Average gross rents in prime Raffles Place offices rose 7.1% quarter-on-quarter (q-o-q) to S$9 per sq foot a month. In 3Q2010, rental values rose 6.3% q-o-q. For 2010, average prime gross rents in Raffles Place increased 13.9%, said DTZ. “Despite earlier concerns of the hollowing-out effect when occupiers upgrade to new buildings, we notice that the vacated space is being taken up readily by existing tenants wanting to expand or occupiers from other buildings,” said DTZ in a report.
Now, available office space is expanding, with about three million sq ft of new supply likely to be completed in 2011. DTZ estimates that 8.2 million sq ft of net lettable space will be available between 2011 and 2015. OSK-DMG said it is likely to be absorbed by demand.
In the latest Global Financial Centres Index, a twice-yearly index ranking of 75 international financial centres produced by London think-tank Z/Yen, Singapore was identified as one of the financial centres that will become more significant in future, and survey respondents also picked the city-state as one of the financial centres where their companies are most likely to set up an office.
“We expect Suntec REIT to be a major beneficiary of the strong growth outlook in the prime office sector, with its Suntec City office occupancy having chalked up five straight quarters of growth to reach 98.1% in 3Q2010,” OSK-DMG said in its report. The REIT also provides an attractive prospective yield of 6.5% for FY2011, compared with its office peers’ average of 5.6% as well as a yield spread of 400 basis points, the report added. With a debt-to-asset ratio of 40%, however, it has higher gearing than its peers CCT and K-REIT.
Industrial REITs in vogue
Industrial property REITs tend to trade at higher yields and lower P/BVs than the other sectors. One reason is that the leasehold tenure for industrial property is often shorter than that of other asset classes. Industrial property land tenure is usually 30 years+30 years. Usage of industrial space is also more strictly regulated than commercial and retail.
On the other hand, rents for industrial properties tend to be more stable than offices, for example. In its strategy for 2011, CIMB has one REIT among its top picks, Cache Logistics Trust, citing its defensive, low-beta qualities. “Despite recent attention on industrial REITs, Cache has lagged peers, likely owing to its much smaller market cap,” CIMB said in its report.
Since its initial public offering last April at 88 cents, it has climbed 10% and is now trading at a forward yield of 8.8%. “Acquisition announcements could catalyse this stock, particularly when P/B valuations are less demanding than its peers’,” CIMB says in its report. It reckons that S$220 million worth of acquisitions over 2010/11 could boost DPU materially, in view of Cache’s small portfolio and significant debt headroom.
As the stock market moves into perhaps a tougher year in 2011, the right REITs might still help investors achieve a good balance of risk and return.
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