Morningstar Equity Analyst Ken Foong discusses the pandemic’s impact on Singapore REITs and shares his smarts on where value is emerging for investors who have their sights set firmly on a blue horizon.
By Ken Foong
Singapore’s retail exposed REITs are undoubtedly among the worst hit sectors by the ongoing COVID-19 outbreak. With ongoing circuit breaker and enhanced safe distancing measures expected to drive further declines in shopper traffic at major malls whilst dramatically reducing the number of staff travelling to office sites, there is no denying the headwinds in the near term.
The government’s latest announcement to reopen the economy in three phases also indicates that any return to normalcy will be gradual and staggered over the rest of 2020. However, there are still pockets of value emerging for long-term investors who are willing to look beyond the outbreak.
Opportunities emerge in undervalued retail exposed trusts
In the near term, uncertainties remain as the duration of the COVID-19 crisis is ultimately unknown. Suburban malls could indeed fare better in the current environment due to more residents working from home, as compared to urban malls that are more reliant on the tourism sector.
Over the long term however, we see value emerging across three retail exposed REITs, namely CapitaLand Mall Trust, Frasers Centrepoint Trust and Suntec REIT, following roughly 22% declines in unit prices year-to-date+. Despite this, we expect long term DPU growth to be underpinned by strong fundamentals, including population growth, a growing middle-income class, favourable supply-demand dynamics and proactive asset enhancement to meet the ever-evolving retail landscape.
CapitaLand Mall Trust (CMT) in particular has a good record of adding value to its portfolio through asset enhancement initiatives (AEI), actively managing its tenant and trade mix, as well as redeveloping existing properties. In line with the shift to online shopping and advancements in technology, CMT redeveloped Funan by incorporating technology features into the mall’s physical spaces, giving consumers the feel of shopping in the future. For instance, food courts feature self-ordering kiosks, food-collection conveyor belts, and robots for returning trays and crockery.
The integration of online shopping checkouts within its brick-and-mortar stores also enables drive-through, click-and-collect and hands-free shopping services, where shoppers choose to collect their purchases at the drive-through or at the concierge when they are done, or have their shopping bags delivered to their homes.
Such initiatives have delivered solid rental and income growth for CMT through the years. Near-term growth will continue to be supported by the upcoming merger with CapitaLand Commercial Trust, expected to be completed by the second half of 2020. The combined entity will be named CapitaLand Integrated Commercial Trust, and will become the largest REIT in Singapore and the third largest in the Asia-Pacific by market capitalisation.
Frasers Centrepoint Trust, or FCT, owns a portfolio of high-quality retail properties located in suburban areas across Singapore. Its malls are surrounded by residential areas of high population density and are well connected by subway stations and transport hubs, which make them easily accessible to consumers. Most of its malls are in areas where there are no or limited large competing malls nearby, which makes them the main shopping malls serving the population within the vicinity. These result in growing footfall and annual turnover, allowing FCT to charge premium rents relative to average market rates. Acquisitions of a 40% stake in Waterway Point and a 24.8% stake in PGIM Real Estate Asia Retail Fund in 2019 are also expected to drive near-term growth.
While FCT has not escaped being adversely impacted by weakening consumer sentiment, safe distancing and circuit breaker measures in the first half of 2020, the trust should continue to benefit from population growth along with its large residential catchment area in the long term. We also expect the trust to continue to generate long-term value for its investors through active portfolio management and AEI such as better utilisation of floor space, increasing net leasable area, and improving their tenant and trade mix.
Suntec REIT is a commercial REIT that focuses on an integrated mix of offices, retail spaces and convention centres. The trust has been actively undertaking asset enhancement across its office component, whilst a range of retail boosting initiatives, tenant remixing and floor space reconfiguration at its mall are expected to improve the rental income for Suntec City going forward. The trust also recently acquired two properties in Australia, 55 Currie Street and 21 Harris Street in 2019, in order to further diversify its portfolio and generate long-term growth for unitholders.
These acquisitions, coupled with the trust’s development of integrated property 9 Penang Road, completed in 2019, and Melbourne-based development Olderfleet, due for completion in 2020, are positive growth indicators in the near term.
Suntec REIT is also uniquely attractive due to its diversification across office, mall and convention centre properties, as well as strategic locations in Singapore and Australia, which will enable the trust to be more resilient through market cycles and generate continued value for investors.
Navigating the new normal
Since the announcement of the government’s Unity Budget in February, and the supplementary Resilience Budget and Fortitude Budget rolled out in March and May, retail REITs have been focused on implementing tenant support packages and various measures to help alleviate short-term cashflow challenges as businesses scale down their operations, reducing costs and headcount to conserve cash. These include passing on property tax and rental rebates, and allowing the use of one month’s security deposit to offset rental payments, with some allowing tenants to convert security deposits into bank guarantees.
In order to increase customer footfall and sales for tenants, retail trusts have also boosted marketing efforts through promotions, rebates and free parking at selected hours to attract people to visit their retailers in the early stages of the COVID-19 outbreak. However, since the implementation of additional safe distancing protocol and circuit breaker measures, retail trusts are actively adapting their marketing efforts to comply with these new measures.
Given the ongoing challenges and costs in the near-term, it is possible REITs may delay portions of their distributions to a later date up to a year after its financial year end, or provide the option for unitholders to participate in a distribution reinvestment plan to preserve cash as disruptions to day-today operations continue. Given this, investors should continue to expect unit price movements of REITs to remain volatile for the rest of 2020.
Taking the long view, S-REITs underpinned by strong fundamentals
Despite such near-term pressures on operations and cost, the impact is temporary and sufficiently buffered by strong fundamentals. REITs balance sheets today remain sound and are better positioned compared with the pre-2008-09 financial crisis. Average interest rates and leverage ratios remain low at around 2.8% and 35%, respectively based on pre-COVID-19 data as of December 31, 2019.
The increase in regulatory aggregate leverage ratio limit to 50% from 45% increases the debt headroom and provides more flexibility for REITs to navigate through this period. We also don’t see any debt refinancing issues in the near term. Taking a long-term view is therefore key for investors committed to this asset class.
Looking past the COVID-19 crisis, we see a rare opportunity for investors to own resilient 4- and 5-star rated retail exposed S-REITs with attractive dividend yields. As the world positions for a post-COVID-19 reality, well-diversified REIT portfolios that undertake proactive asset enhancement to evolve with the ever-changing consumer landscape will remain resilient in the long run.
(Ed. Morningstar Investment Singapore Equity Analyst Ken Foong is an expert in capital machinery and REITs sectors. Before joining Morningstar in 2017, Foong says he spent three years as an equity analyst at Goldman Sachs in London, where he covered the European steel sector. Foong has a bachelor degree in accounting and finance from the London School of Economics and Political Science. He also holds the Chartered Financial Analyst designation.)