Friday 17 October 2008

Falling rents may take shine off S-Reits

SINGAPORE-LISTED real estate investment trusts, or S-Reits, are now finding favour with analysts.

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Guanyu said...

Falling rents may take shine off S-Reits

By UMA SHANKARI
17 October 2008

SINGAPORE-LISTED real estate investment trusts, or S-Reits, are now finding favour with analysts.

UOB Kay Hian, for example, upgraded the S-Reit sector from market weight to overweight earlier this month due to the ‘overwhelmingly attractive’ yield spread. JPMorgan similarly said in a recent report that the Reit model is not broken. The research firm has ‘buy’ calls on seven S-Reits. Analysts from other research firms have also been recently issuing ‘buy’ calls on several Reits here.

This is quite a reversal from a year ago, when the S-Reit sector was considered unattractive. Many Reits were facing concerns about their ability to refinance debt amid the credit crunch. Acquisitions, which had been fuelling growth, were also becoming harder to come by.

But now, some of these Reits are seen to be sources of stable, visible and recurrent income in uncertain times. Yields are also at historic highs as stock prices continue their downtrend.

Analysts are now saying that debt refinancing will not be an issue for all Reits. For one, strong sponsors could act as lenders of last resort for Reits and prevent any fire sale of assets. Retail and industrial Reits are the most exposed to refinancing risk. So investors are encouraged to buy those Reits with strong sponsors and avoid certain sectors.

But the one thing that has been largely overlooked in most analyses is the impact of falling rents.

Rents will fall across most sectors - that much is certain. Office trusts, such as K-Reit Asia and CapitaCommercial Trust, will be among the first to be hit.

The massive upheaval in the banking system means that financial institutions are unlikely to continue with any expansion plans yet to be executed. Other businesses will have reduced access to bank credit and scale back expansion plans. With a reduced appetite for space and looming new office supply coming onstream in 2010, landlords are losing their bargaining power and rents will inevitably fall.

Kim Eng Research, for one, expects prime Grade A office rents to fall by up to 15 per cent by the end of 2009.

Rentals for retail Reits will also fall. Already, there are signs from retailers in Reit properties that they cannot afford the high rents being charged at the moment. Retail spot rents are being hit by slowing economic growth and falling visitor arrivals amid increasing supply. Goldman Sachs yesterday said that it expects retail rental rates to fall 15 per cent between now and 2010.

Reits here typically renew their leases on a revolving basis, with a certain fraction of tenants re-signing every year. So those tenants who signed three-year leases last year could be stuck forking out high rentals for another year or two. But tenants renewing their leases soon will ask for lower rents. In a couple of years - say, by 2010 - the bulk of a Reit’s tenants could be paying lower rents, leading to lower rental incomes for S-Reits. Their yields are not likely to look so attractive then.

Analysts are now beginning to factor falling rents into their calculations. Goldman Sachs yesterday downgraded K-Reit from ‘buy’ to ‘neutral’. ‘We have been positive on K-Reit, given its attractive pricing relative to book value and our expectation that organic growth for the next two years at least will still find good support from positive rental reversions,’ said the firm in a report. ‘However, we underestimated the focus by investors on the direction of spot rents and were not sufficiently conservative in terms of how far Singapore office rents could decline from their peak.’

However, even with falling rents factored in, S-Reits can be attractive, some maintain. After imposing worst-case operating assumptions for each property sub-segment, including a blowout of financing costs and accelerating the rental reversions to the entire portfolio, Daiwa Institute of Research’s David Lum still estimates that all S-Reits could deliver recurrent worst-case yields of at least 6 per cent per year.

But whether making ‘buy’ or ‘sell’ calls for S-Reits, it’s important to factor in the impact that falling rents will have on S-Reit rental incomes over the next 2-3 years. Refinancing is not the only concern.