The team at OCBC Investment Research (OIR) says it foresees higher inflationary pressures to be a concern on the impact of margins on the Singapore REITs (S-REITs) sector.
Amid the inflationary pressures, interest rates are poised to increase further as central banks are likely to raise their benchmark rates in 2022, notes the team.
“Although this could result in higher borrowing costs ahead, we believe the S-REITs under our coverage have continued to be prudent on their capital management. The average gearing ratio stood at 37.4%, as at Dec 31, while 74.4% of their borrowings are fixed or hedged, which would mitigate the expected increase in borrowing costs ahead,” writes the team in their March 1 report.
That said, mitigating factors identified by the team include the S-REITs buying electricity in bulk, the REITs which have larger sponsors.
The REITs could also pass on the higher utility costs to tenants in the form of higher service charges, which is another mitigating factor.
Other factors include tighter cost controls and use of automation and technology to reduce manpower costs such as security contracts, lease structures which have annual rental escalations, direct Consumer Price Index (CPI)-linked indexation and,or periodic market rent reviews which would help to buffer the increase in cost inflation, adds the team.
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To be sure, Singapore’s CPI rose 4% y-o-y in December 2021 while core CPI increased by 2.1% y-o-y.
To this end, the team’s preferred picks for the basket of reopening or recovery plays comprise Ascott Residence Trust (ART) and CapitaLand Integrated Commercial Trust (CICT).
“On the other hand, S-REITs we like with exposure to new economy assets which we believe are more resilient and defensive over the longer run are Ascendas REIT (A-REIT), Frasers Logistics & Commercial Trust (FLCT) and Mapletree Industrial Trust (MINT),” they add.
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The team has given “buy” calls to ART, CICT and A-REIT with target prices of $1.22, $2.44 and $3.63 respectively. They have also pegged target prices of $1.66 for FLCT and $3.30 for MINT.
According to the team, from 2005 to 2021, there was a meaningful positive correlation between the y-o-y change in the Singapore CPI and corresponding y-o-y changes in both the Singapore property price and rental indices. “Our findings show that the residential and industrial sub-sectors have the highest correlation between CPI changes and growth in their respective capital values and rents, while the retail sub-sector has the lowest correlation,” they say.
“Core inflation could pick up pace to reach 3% by the middle of the year before easing in 2H22 as external inflation recedes, according to Monetary of Authority (MAS),” says the team.
In the US, the high headline inflation numbers have caused jitters in the financial markets, with last reported January 2022 CPI growth coming in at 7.5% on a y-o-y basis. According to the team, US core CPI jumped 6.0% y-o-y for the same period.
Industrial
Within the industrial sub-sector, A-REIT highlighted during its FY2021 analyst briefing that it expects its electricity costs to increase by 50-70% from the average in 2021. Utilities also accounted for 19% of its total property operating expenses in FY2020.
“While the increase is significant, management said it might be able to recover a portion of the increase via higher service charges in Singapore,” says the team. “For its overseas assets, majority of the increase in utility expenses can be recovered from tenants, with the exception of vacant spaces.”
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“As for rental escalations which would help to buffer cost inflationary pressures, its Singapore single-tenanted buildings and longer leases typically come with [an estimated] 2% annual rental escalations”, add the analysts.
FLCT’s Australian logistics and industrial properties generally have fixed increments averaging 3.1% per annum, while most of its European assets have CPI-linked indexation embedded in their leases.
As for FLCT’s commercial portfolio, its leases in Singapore and the UK are generally marked-to-market on lease renewals, while commercial leases in Australia generally have fixed annual increments averaging 3.3%, according to the team.
MINT said that in light of rising utility costs, it will install more energy efficient fit-outs such as the use of motion sensors at staircase landings, corridors and toilets, and will make use of technology to reduce reliance on manpower. “We believe warehouse as an asset class in generally has lower intensity of energy and water usage. Typically only 10-20% of total warehouse energy costs relates to common area which is borne by the landlord, while tenants have to bear the remaining 80-90%,” says the team.
In addition, there are also built-in rental escalations for approximately 80% of its portfolio revenue, most of which are on fixed rates and minority is CPI-linked. The fixed annual rental step-ups range from 1-4%, and are higher for its assets in China, Vietnam, Australia, Hong Kong and India.
Commercial
During CICT’s results briefing, the REIT highlighted that its energy consumption should increase in correspondence to more people returning to the workplace as compared to 2021, coupled with higher tariff rates.
“While only some of CICT’s leases have step-up rentals, its gross turnover rents now constitute 4-10% of its retail gross rental income. This suggests that if retailers raise their prices due to higher inflation, CICT would be able to benefit in the form of higher gross turnover rents,” the team says.
Mapletree North Asia Commercial Trust (MNACT) told the OCBC team that it will continue to control tightly its operating costs and continuously seek to improve cost efficiencies across its properties. Approximately 97% of leases at Festival Walk (including both retail and office leases), 24% of leases at Gateway Plaza, 11% of leases at Sandhill Plaza, 3% of leases at the Japan Properties and 94% of leases at The Pinnacle Gangnam have step-up structures in the base rent, as of March 31.
Additionally, utilities formed only 2.9% of Suntec REIT’s total property operating expenses in FY2-20. Its Singapore leases do not typically come up annual rental step-ups, but for Australia, there are annual rental escalations of between 3% to 3.5%. In the UK, there are market rent reviews every five years, with adjustments based on the higher of existing or market rents.
Hospitality
ART said that it has streamlined its cost structure since the pandemic, such as reducing its headcount, making better outsourcing arrangements and getting consumers to book directly via its website instead of online travel agencies (OTA), says the team.
“Most of its master leases in Australia and Germany are pegged to inflation-linked indices. It has also penetrated into the student accommodation sector, where leases are typically renewed every year prior to the academic year and hence room rates can be adjusted upwards to factor in higher costs given improving industry demand and supply dynamics,” they add.
