SINGAPORE (Jan 29): Industrial property rents have been drifting lower in the last 24 months. This has been reflected in the results reported by four industrial real estate investment trusts since the start of the year. Their net asset values per share have fallen, from 6% y-o-y for ESR-REIT to as much as 11% for Soilbuild Business Space REIT (see table). Industrial properties owned by REITs are valued based on cash flow and future rental assumptions. The declines in NAV are no surprise, since industrial rents have fallen in line with JTC’s rental price index. This stands at 99.1 in 3Q2017, down from 140 in 1Q2014. The chart shows the decline in the industrial rental index since it reached a plateau in late 2012.
Vacancy rates are still in the high single digits to low double digits for various industrial property types. According to Cushman & Wakefield, supply and absorption of warehouse space rose in tandem last year. Net supply for the first three quarters of 2017 amounted to 8.1 million sq ft, more than the full-year supply of 6.3 million sq ft in 2016. Net absorption of 4.9 million sq ft was also considerably higher than the full-year absorption of four million sq ft in 2016. Since supply outstripped demand, the warehouse vacancy rate has risen to 12.5% in 3Q2017.
But, an inflection point is on the horizon. Vikrant Pandey, director, Asean & Hong Kong property and REITs, at UOB Kay Hian, says industrial property rents could start picking up next year. Indeed, Cushman & Wakefield is expecting supply of warehouses to start moderating. It points out that 2.7 million sq ft of warehouse space is slated for completion in 2018, below the 10-year annual average warehouse absorption of 3.5 million sq ft, and well below FY2017’s supply. Warehouse supply will further decrease to 1.5 million sq ft in 2019, it adds.
“It is good news that the government is trimming its industrial land supply for 1H2018, reflecting the government’s sensitivity to the relatively fragile state of the industrial property market in Singapore, despite the uplift in economic and trade conditions,” notes Daniel Cerf, CEO of Cache Logistics Trust’s manager.
Indeed, if absorption stays at current levels, industrial REITs with logistics assets could benefit, and Pandey’s prediction may well turn out to be prescient. Cache would be a prime beneficiary.
Local logistics proxy
Two REITs — Mapletree Logistics Trust (MLT) and Cache — invest only in logistics assets. Of the two, Cache faced a more challenging environment. Its distribution per unit (DPU) has been falling in the past two years, in line with an oversupply in warehouse space in Singapore. Some 82% of its portfolio by valuation and 83% by gross revenue is from Singapore; 17% by value and 16% by revenue is from Australia. The remainder is from one asset in China that clearly does not quite fit.
The diversification into Australia helps lengthen its land tenure. In 2015, Cache decided to acquire assets Down Under for their freehold status, long weighted average lease to expiries and higher net property income (NPI) yields.
Last November, a major overhang for Cache was removed. The REIT announced an amicable resolution of a property whose lease was in dispute. Cache was paid $8.2 million and has entered into a fresh lease with the tenant, Schenker, for the entire property for the period of Nov 1, 2017 to Aug 31, 2021. The property, 51 Alps Avenue, was master leased from C&P Holdings at IPO. The lease expired in August 2016, whereupon Schenker exercised its option to renew the lease at a pre-agreed rent with C&P, but below market rents.
Although Cache’s DPU and NAV continued to fall y-o-y, quarterly DPU for 4QFY2017 rebounded slightly to 1.59 cents from 1.54 cents in 3Q.
Now, Cerf is cautiously optimistic about the outlook for warehouse rents. He says, “The rate of decline of industrial rents has fallen, although rentals are still soft. What we do hear on the ground is that, with a visible reduction in supply, and demand coming through with the synchronised global growth that everyone’s talking about, we should see stronger demand emerging throughout the course of the year, and rents should start to bottom out by year-end if that demand holds.”
Demand for logistics assets is closely tied to trade. Economists believe Singapore’s trade-driven growth is likely to continue. Last year, Singapore clocked a 3.5% expansion in GDP, underpinned by a recovery in its manufacturing sector, which surged 18.4% y-o-y in 3Q2017. Factory output continued to rise rapidly at 14.6% y-o-y in October, bolstered by robust electronics output, which surged 45.1% y-o-y. The November manufacturing Purchasing Managers’ Index rose 0.3 points to 52.9, remaining positive for the 15th consecutive month and reaching an eight-year high.
Unlike Singapore, which is a cyclial market, Australia provides Cache with stability. “GDP growth remains healthy [in Australia] and is likely to average 3% over the next few years, as business conditions are positive and capacity utilisation has increased. The outlook for non-mining business investment has improved further and increased public infrastructure investment is supporting the economy. It is anticipated that yields will remain stable with long-run growth in industrial property values in the Eastern Seaboard states,” Cerf says.
RHB Securities upgraded Cache to a “buy” on Jan 19. The resolution of 51 Alps Avenue, coupled with the sale of 40 Alps Avenue above valuation and its rights issue last year, will reduce gearing to 32.9%, RHB says. That leaves it with debt headroom of $160 million, with which it could acquire a yield-accretive property in Australia.
High-tech industrial could rebound
The rebound in electronics manufacturing is positive for the high-tech sector. “With industrial economic indicators remaining positive, continued manufacturing growth will support future rental increases. As the electronics cluster is the main driver of manufacturing sector, high-tech rents are expected to increase 2% to 3%,” says Cushman and Wakefield on the outlook for this year.
ESR-REIT, which has a diversified portfolio, is also looking at industrial rents stabilising in the next 12 months. “Based on past experience, the time lag between economic activity and impact on industrial space rentals is generally nine to 12 months,” the REIT said in a statement.
ESR-REIT acquired two high-specification, high-tech properties last year: 8 Tuas South Lane, which houses the manufacturing facilities of Hyflux’s membrane technology, for $95 million; and 7000 Ang Mo Kio Ave 5. The Tuas property is near Tuas Megaport, the world’s largest container terminal, to be opened in stages from 2021.
The AMK property is a high-specification, high-tech property with quality tenants such as SP Services, StarHub and Heptagon Micro Optics. It was once a pipeline property for Viva Industrial Trust. According to Adrian Chui, CEO of ESR-REIT’s manager, 7000 AMK Ave 5 has an unused plot ratio that can be developed, but he prefers the additional development to be from a build-to-suit tenant.
ESR-REIT reported a 7.7% decline in DPU to 3.853 cents for FY2017. Fourth-quarter DPU was still 3.6% lower than 3Q DPU of 0.964 cents. The rate of decline has almost halved, though. “We will try our best to make sure the DPU will stabilise and we will probably see negative rental reversions. But there are other opportunities and accretive acquisitions we can make and we can manage our capital structure better. With 100% unencumbered assets, we are getting competitive margins [for debt],” Chui says.
Business parks still the favourite
Industrial property has a few layers. At the top of the heap, business parks are the Grade A of industrial property. In some cases, tenants are said to prefer suburban and city-fringe business parks to older office buildings. There is anecdotal evidence of a tenant who declined rents of $6 psf per month at OUE Downtown’s office tower in favour of a suburban business park charging $7 psf pm.
Business parks are likely to benefit from a spillover in office demand. According to JTC’s 3Q2017 data, vacancies dropped 0.2 percentage point to 14.1%, the lowest since 2013. Transacted value for leasing in 3Q2017 more than doubled to $2.7 million, from $1.1 million in 2Q2017. Ascendas REIT, which has the best-quality business parks, is analysts’ favourite pick.
Geographic diversification
One way to alleviate the pain of falling DPU and NAV is to diversify out of Singapore into where prospects are brighter or the sector is in a different part of the cycle. MLT pointed out that the Singapore market continues to face pressure from a high supply of warehouse space. The REIT managed to raise DPU by 2% y-o-y and 1.06% q-o-q to 1.9 cents for the three months to Dec 31, its third quarter. Its annualised DPU also rose 2% to 7.55 cents.
Global growth has improved and this is expected to have a positive impact on MLT’s pan-Asian portfolio. By revenue, its largest markets are Singapore, which contributes 34.8%; followed by Hong Kong, with 20.7%; Japan, 15.2%; and Australia, 9.2%. On Jan 5, MLT completed the acquisition of a stake in Shatin No 3 in Hong Kong which it did not already own, for HK$610 million ($103.7 million), taking its total stake to 100%. Full ownership affords MLT the flexibility for asset enhancement initiatives, including refurbishment and asset repositioning strategies, enabling the property to generate a higher yield and better valuations. Shatin No 3 was initially a strata-titled logistics asset that MLT started acquiring piecemeal in 2006.
On Oct 12, MLT also completed the acquisition of Mapletree Logistics Hub Tsing Yi in Hong Kong for HK$4.8 billion. NPI yield for the property is 5.7%, 1.25% higher than the yield on MLT’s Hong Kong portfolio. MLT’s NAV rose one cent y-o-y and two cents q-o-q to $1.05 on Dec 31.
Demand-and-supply metrics for industrial property
Even though Broadcom announced its intention to relocate its headquarters to the US, it has not been doom and gloom for Singapore’s industrial sector. Other MNCs are relocating to the city state. In 4Q2017, GSK (formerly GlaxoSmithKline) officially opened its Asian headquarters GSK House at One-North. Specialty food ingredients maker Roquette opened its regional headquarters-cum-innovation centre in Biopolis.
“With industrial economic indicators remaining positive, continued manufacturing growth will support future rental increases,” Cushman and Wakefield says in its 4Q2017 industrial property outlook. As the electronics cluster is the main driver of the manufacturing sector, high-tech rents are expected to increase 2% to 3% in 2018, the consultant forecasts. With business park demand sustained by cost-conscious companies and future supply remaining limited, rents for quality business parks in the city fringe are projected to rise 3% this year, it adds.
Interestingly, new business park supply has shrunk dramatically. No new business park projects were completed last year. In addition, business park net absorption for the first three quarters of 2017 amounted to 0.7 million sq ft, compared with 1.8 million sq ft in 2016. CBRE says business park vacancy rates in 4Q2017 dipped to 11.8% q-o-q (see chart).
According to ESR-REIT’s FY2018 market outlook, overall supply is likely to abate. JTC estimates that 2.3 million sq m of industrial space, representing 5% of current industrial stock, will come onstream until year-end, but limited supply is expected from 2019 to 2021.
