Property & REITs :
Outlook beyond tapering
Interest rates remain our key worry for 2014. While household balance sheets are sound, the uncertainty stems from how far interest rates can rise. Our property analyst, Donald Chua, estimates that the average mortgage-to-income ratio for private homes is currently 29%, significantly below figures during the last two peaks (2007: 40%, 1996: 48%). Median income, having risen by a 7% CAGR from 2010 to 2013, should still rise on tight unemployment. Housing demand has shifted to smaller units (average of 1,270sf in 2006 vs. 970sf now), so the holy trinity of higher wages, lower leverage and smaller houses should mitigate a crash in physical prices if interest rates spike. The bugbear beyond 2014 is supply; that is well-known. Physical completions are expected to jump in 2015. The URA expects the addition of 19.7k (2015) and 26.5k (2016) private units vs. an average 7.5k completion rate in the last 10 years. As immigration policy tightens and population growth stagnates at 2%, vacancy rates have started climbing (2Q13: 5.6%, 3Q13: 6.1%). We expect vacancy rates to peak at 7.0-7.5% and physical prices to decline by 15% by 2015.
We are most positive on the Singapore office segment. Grade-A rents have stabilised at S$9psf and average occupancy rates have stabilized at 96.1%, according to Jones Lang LaSalle (slight dip in 3Q13 due to the completion of Asia Square Tower Two). We believe the oversupply in the past few years has been largely digested. More sanguine hiring expectations could lead to stronger employment in 2014, supported by a recovery in GDP growth, particularly in the service sector (2014E: 5-6%). A recovery in the latter typically leads to a recovery in net office space take-up. With the supply of prime-grade office space expected to average 0.8m sf a year in the next three years compared with the historical average take-up rate of 1m sf per year, the demand/supply dynamics is turning favourable for landlords. We believe rents have bottomed.
We forecast average Grade-A rents to rise 8% in 2014 (pre-leasing pickup in 2H14) and 6% in 2015. Fed tapering is the near-term risk, as higher interest rates may prevent a spike in commercial cap rates. Our counter to this is that rents (+0.9 correlation) and vacancy rates (-0.9 correlation) have had higher correlations with capital values in the past 10 years, while the relationship between interest rates and capital values has been spurious. Capital values for prime-grade office properties remain 15-20% below their previous peak, against a backdrop of bottoming rents. We maintain our cap-rate assumptions of 4-4.5%, around 50-75bp higher than current market levels and implying 13-27% discounts to asset values. We think this is fair.
We view Singapore developers with China exposure as good alternative proxies for China consumption. Residential sales volume is picking up and bodes well for 2014-15. The main competitive edge Singapore developers have in China is their expertise in managing commercial/logistics properties. Same-store rental growth for retail malls and logistics facilities has moderated slightly but is still a respectable 7-8%. Operating metrics for retail-mall operators (CMA and CAPL) are trending up, driven by improving yields on costs. We expect this trend to continue. The recent launch and close of the world’s largest China-focused logistics infrastructure fund by GLP was, in our view, a milestone for the developer.
We see this as a major stock catalyst, helping GLP scale up substantially in a capital-efficient manner, accelerate its fee-income growth and
kick-start its China asset recycling. In the modern logistics property market in China, GLP remains the clear leader. We expect NAV for GLP to rise by 12-15% per year in 2014-15 on: 1) a 20% yoy increase in China rental income as more assets are completed; and 2) a compression of cap rates triggered by the launch of its logistics infrastructure fund; and 3) the possible establishment of other such funds.
Our REIT analyst, Pang Ti Wee, sees two things driving REITs: 1) contracting yield spreads as risk-free rates head up; and 2) individual REITs’ ability to raise their DPU payouts to counter the headwinds of rising finance costs. Of the ways to increase DPU (AEI, rental reversions, acquisitions), acquisitions are the most direct and immediate. Unfortunately, with compressed cap rates for commercial properties currently, S-REITs are finding it difficult to make yield-accretive acquisitions without stretching their gearing. Also, with limited targets to acquire in Singapore, overseas acquisitions, particularly in China and Australia, will increasingly be the norm. We favour REITs with the strong corporate governance to do deals that make sense. On this basis, SUN (acquisition in Australia) and FCT (Changi City Point) are our top picks. Risks for REITs include: 1) expensive and risky acquisitions; and 2) dilution from equity fund-raising to lower debt.
Among the subsectors, we believe that Office rents have bottomed and expect rental growth in 2014 (6-8%) to accelerate in 2015, the result of diminished Grade-A office supply and a growing service sector in Singapore. Retail rents remain supported by full employment and good pre-commitments (80-100%) ahead of physical completions. Industrial REITs could face a short-term oversupply, particularly of business-park space, as a large amount of business-park space (1.3m sf in 2013, 1.2m sf in 2014) comes onstream. In the Hotel segment, growth in new rooms (average of 3,000 rooms per year between 2013 and 2015) could be 5.8% in 2014, still slightly ahead of expected demand growth of 5%. RevPAR weakness is well-known and further weakness is expected in 2014, albeit lesser. As the new supply of rooms gets digested, a stronger turnaround in global economies and corporate travel may stabilize RevPAR in 2014.
We are negative on developers with pure Singapore exposure, especially in the housing market. We prefer players with limited or no Singapore residential exposure, are leaders in their respective sub-segments outside Singapore and have valuation support. Our top picks are GLP, UOL and CAPL. For REITS, we prefer stocks that can still grow through AEI. Our top pick among the large caps is SUN for its well-executed AEI at Suntec City, which should boost earnings, particularly when Phase 2 becomes operational after 1Q14. Other interesting smaller players which could continue to grow through AEI and small acquisitions include FCT, FCOT, Cache, Cambridge.
Publish date: 02/12/13