• The S-REITs Index rebounded 6.7% in November after falling 6.9% in October, on expectations of the end of the Fed interest rate hiking cycle.
• S-REITs are now trading at a forward dividend yield of c.6.4%, 0.4x s.d. above the mean of 6.1% and a P/NAV of 0.86x, 2x s.d. below the mean of 1.03x. We think this is an opportune time to reposition into S-REITs for the eventual interest rate pause and decline.
• We remain OVERWEIGHT on S-REITs, especially now that Fed policymakers are signalling a 75bps cut in the federal funds rate after its 13 Dec 2023 meeting to between 4.5% and 4.75% in 2024. We continue to favour REITs with a healthy balance sheet, strong sponsor, and improving operating metrics such as REITs in the hospitality and retail sub-sector. Catalysts are expected from a pick-up in the economy, asset recycling and interest rate cuts. Top picks are CapitaLand Ascott Trust (CLAS SP, BUY, TP S$1.04) and Frasers Centrepoint Trust (FCT SP, ACCUMULATE, TP S$2.29).

SECTOR ROUND-UP

The FOMC held the federal funds rate unchanged at 5.25-5.5% for the third straight meeting on 13 Dec 2023, and are now signalling that it expects to make three 25bps rate cuts next year. This will be a tailwind for REITs, and we expect a sector recovery in 2024-2025.

SPECIAL FOCUS: Manulife US REIT restructuring

Manulife US REIT (MUST SP, non-rated) announced a recapitalisation plan to address the breach of financial covenants. The first step is to raise US$285mn of funding to pare down debt through: 1) a proposed divestment of Park Place to the sponsor at US$98.7mn, which is the higher of two independent valuations; 2) a six-year unsecured Sponsor-Lender loan of US$137mn at an interest rate of 7.25%, with an exit premium of 21.16% which translates to an effective interest rate of c.10% p.a. and 3) utilisation of US$50mn from MUST’s own cash holdings.

The next step is to pursue a disposition mandate to raise a minimum of US$328.7mn through asset dispositions, where assets are prioritised based on total return potential, capital expenditure requirements etc. Tranche 1 assets are prioritised for sale, and they comprise Centerpointe, Diablo, Figueroa, and Penn. These assets have the highest occupancy risk, highest capital expenditure requirements, and lowest total return potential. Also, as part of the recapitalisation plan, half-yearly distributions will be halted till 31 December 2025, but may resume if certain early reinstatement conditions are achieved. These conditions are: 1) consolidated total liabilities to consolidated deposited properties is no more than 45%; or 2) consolidated total liabilities to consolidated deposited properties is more than 45% but less than 50%, and interest coverage ratio is more than 2.5x, and there are no potential events of default continuing for at least one financial quarter.

In return for the above, the lenders will: 1) waive all past and existing breaches; 2) temporarily relax unencumbered gearing ratio to 80% from 60%, and bank ICR from 2x to 1.5x till 31 December 2025; and 3) extend all existing loan facilities by one year.

Post-recapitalisation, aggregate leverage could decline to 49.4%, and NAV/share could drop to 0.34x. The key concern of the market is the high interest costs for the sponsor’s loan, but we agree with the independent financial advisors that the effective interest rate of c.10% is reasonable considering comparable debt instruments as well as the lack of financing options for US office. Post sponsor loan and excluding the exit premium, MUST interest rate will rise by c.50bps to c.4.9%. The results of the Extraordinary General Meeting on 14 December are out, and all three resolutions were duly passed by unitholders by way of poll. MUST will now begin execution of this recapitalisation plan.

Separately in November, Mapletree Logistics Trust (MLT SP, non-rated) announced the proposed divestments of three properties: 1) 10 Tuas Avenue 13 at S$11.11mn, 15.7% above its latest valuation; 2) Flexhub, located in Senai, Johor, for MYR125.1mn, 7.4% above its latest valuation; and 3) Padi, located in Pasir Gudang, Johor, for MYR26.1mn, 16% above its latest valuation. The capital released from the divestments will provide MLT with greater financial flexibility to pursue investment opportunities in high-specification, modern logistics facilities with higher growth potential.

Retail

Oct 23 retail sales index (excluding motor vehicles) fell 1% YoY, declining from the 0.7% growth in Sep 23. The F&B services index grew 2.4% YoY in Oct 23, extending the 6.9% growth in Sep 23, with food caterers (+19%) experiencing the largest growth. The government handing out cash and the increase in GST next year might cause consumers to frontload some of their discretionary spending to avoid paying that additional 1% tax. This could provide some upside to retail sales towards the end of the year.

Hospitality

Singapore’s international visitor arrivals grew 35% YoY in Nov 23 to 1.1mn, and it is still at 28% below pre-COVID Nov 19. The return of Chinese travellers has been slower than expected, and it is at only 42% of pre-Covid levels. RevPAR fell 10% YoY in Oct 23 partially due to the Singapore F1 Grand Prix being held in October in 2022, while it was held in September in 2023. With average daily rates already surpassing pre-Covid levels, we anticipate the gradual recovery of international visitor arrivals to underpin RevPAR growth going forward.

INVESTMENT RECOMMENDATION

OVERWEIGHT on SREITs (Maintained)

After the rebound in the S-REITs index in Nov 23, S-REITs are now trading at a forward dividend yield of c.6.4%, 0.4x s.d. above the mean of 6.1% (Figure 4) and a P/NAV of 0.86x, 2x s.d. below the mean of 1.03x (Figure 3). We think this is an opportune time for investors to reposition into SREITs for the eventual interest rate pause and decline. However, we think it will remain challenging for S-REITs (apart from the hospitality sub-sector) to grow DPU with higher borrowing costs and forex headwinds expected.

Bloomberg consensus forecasts 2023/24 SG10Y yields at 2.97% and 2.83%, respectively. The dividend yield spread at 3.4% is 0.9x s.d. below the mean of 4% (Figure 2), but we expect it to continue to widen as the SG10Y yield continues to decline.

Sub-sector preferences: Hospitality and Retail (Unchanged)

We think the hospitality sub-sector will be able to generate the most DPU growth on the back of higher RevPAR and the gradual reopening of China as outbound flight capacity from China increases. Suburban retail offers resilience in a downturn while downtown retail stands to benefit from the recovery of international visitor arrivals, which will in turn lift tenant sales and sentiment.

Retail (OVERWEIGHT). With tenant sales still growing YoY and higher than pre-COVID levels, we believe the potential for positive rental reversions is still intact for both downtown and suburban malls. Downtown malls benefit the most from reopening as international visitor arrivals pick up, while suburban malls which focus on essential services remain resilient in a slowdown. There is also very little new supply entering the market. Return to office and a pick-up in major events to be held in Singapore in 2024 should continue to lift tenant sales and give confidence to retailers. The recovery of inbound Chinese tourists has been lacklustre to date, and a stronger recovery in 2024 will help to further boost the potential of higher rental reversions for downtown malls.

Office (NEUTRAL). We think core CBD Grade A office rents at $11.85 psf pm in 3Q23 will come under pressure as the market absorbs more supply coming in 2024 from IOI Central Boulevard Towers (1.2mn sq ft) and Keppel South Central (600k sq ft). More downsizing could occur as global layoffs among tech firms find their way into Singapore. This could affect office leasing momentum and sentiment. Elsewhere, we expect further declines in overseas office property valuations (especially in the US), due to cap rate expansion and weaker operating performance.

Industrial (NEUTRAL). The slowdown in manufacturing and a bleak economic outlook will likely affect industrial property demand. However, industrial REITs are benefiting from the secular growth of new economy tenants such as tech, life sciences, biomedical, semi-con and electronics manufacturing, which typically locate themselves in high-spec, science and business parks, and warehouses. Logistics demand remains strong with demand coming from many third-party logistics businesses.

Hospitality (OVERWEIGHT). With average daily rates already surpassing pre-COVID 19 levels, we think the future growth in RevPAR will primarily come from higher occupancy. Also, the increase in MICE and entertainment events in Singapore will further boost this sector. We believe the hospitality sub-sector has the most potential for DPU growth as its increase in revenue can more than offset any rise in interest expenses and operating costs.

Source: Phillip Capital Research - 15 Dec 2023