Monday, August 5, 2013

Time to reconsider S-REITs?

Time to reconsider S-REITs?
Insider Asia
Written by InsiderAsia    
Monday, 05 August 2013 10:30

Singapore real estate investment trusts (S-REITs) have been among the worst hit in the recent global market selldown. At the worst, prices were down by some 20%  on average since the first hint of tapering by the US Federal Reserve in mid-May.

This is not surprising given that most investors in REITs are yield seekers. Thus, with yields on risk-free government securities rising sharply over the past two months, yields from REITs must correspondingly spike higher — and unit prices lower — to maintain the spread for risks associated with these trusts. Indeed, yields on benchmark US Treasury notes, Singapore government securities (SGS) and average yields on S-REITs have moved pretty much in tandem.

Yields for S-REITs have risen from roughly 5.2% on average, before the latest bout of selling down, to as high as 6.4% before giving back some ground to the current estimated 6.2% or so. The increase tracks closely yield movements on the benchmark 10-year notes for both the US Treasury and SGS, which are now some 1% to 1.1% over the same period.

Fairly good spread over short- and long-term risk-free rates
At prevailing prices, S-REITs are giving investors an average spread of roughly 3.7% over the 10-year SGS, which is in line with the longer-term average. Additionally, short-term rates are still hovering near zero — the US Fed has indicated that it intends to maintain rates at current levels well into 2015, at least.

As such, prevailing returns on S-REITs are quite appealing to investors. Indeed, some market analysts are warming up to select REITs again, after the selldown.

The prevailing consensus is that yields on the 10-year notes will likely end the year between 2.5% and 3%. This implies that much of the potential increase is already priced in, having risen so steeply in just two months. This could put a floor on further downside risks from hereon.

Unless the US economy picks up steam significantly, further yield increases may also be more gradual. Both GDP growth and inflation remain tepid in the first half of 2013 (1H13), although the economy is expected to strengthen in 2H13.

To be sure, interest rates are expected to trend higher over the coming years. The average yield for the 10-year note is about 3.5% in the past decade while the long-term average is around 5%. This will result in higher borrowing expenses for REITs. Positively, gearing for most REITs are within reasonable ranges of between 30% and 40% and many are on longer-dated fixed rate loans, which will mitigate any immediate impact on earnings.

It also bears to note that unlike bonds, income for REITs do expand — through organic rental increases, asset enhancement initiatives (AEI) as well as yield accretive acquisitions. Indeed, most of the S-REITs have established a track record of rising distribution per unit over time.

Stronger earnings from A-REIT
Case in point, Ascendas Real Estate Investment Trust (A-REIT) registered 6.3% year-on-year (y-o-y) revenue growth in its latest earnings results for the first quarter of the financial year ending March 2014 (1QFY14).

The higher revenue of S$150.9 million (RM386.4 million) was attributed to contributions from new property, The Galen — which was acquired in 4QFY13 — and positive rental reversion of 9.6% on average. Income distribution rose to 3.55 cents per unit, up from 3.53 cents in the previous corresponding quarter.

We expect earnings will continue to strengthen. A-REIT completed the acquisition of its second business park in China in July for S$124.6 million and is expected to complete the S$178 million development for Nexus@one-north in 2QFY14. It is also undertaking a number of AEI — capital expenditure totalling some S$120 million — to improve yields on existing properties. These projects are targeted to complete in stages by 3Q14.

Outlook for rental increases is also positive. Rental rates for industrial properties, in general, have trended higher since the global financial crisis. A-REIT expects positive rental reversion going forward as market spot rates are above passing rents of leases due for renewal across all segments of its properties. Furthermore, its long-term leases, which account for some 32% of total asset value, have built in rental escalation.

Some 14.8% of leases (as a percentage of rental income) are due for renewal through the remainder of FY14, down from 21.4% at the start of the financial year. The weighted average lease expiry (WALE) for its portfolio stands at 3.9 years.

A-REIT also estimates modest impact from rising interest rates. Gearing is comparatively low at 28.6% at end-1QFY14. Some 68.1% of total borrowings are based on fixed rates with an average of four years to maturity. It estimates a 2.1% and 4.2% decline in income if interest rates were to increase by 1% and 2% respectively.

To recap, A-REIT is the largest industrial REIT listed on the Singapore Exchange. Its portfolio currently consists of 103 properties, including a business park in Beijing, China, worth a combined S$6.45 billion.

Its unit price reached a high of S$2.86 in mid-April but has since fallen by some 21% to the current S$2.30. At the prevailing price, we estimate investors will earn net yields of 5.9% and 6.4% for FY14 and FY15 respectively — implying a return of some 3.4% to 3.9% above prevailing 10-year SGS yields. The trust is trading at 1.2 times book value, which is right around its longer-term average valuations.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.

This article first appeared in The Edge Financial Daily, on August 05, 2013.

Publish date: 05/08/13

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