Singapore Retail REITs Are on Sale

With several countries beginning a cautious reopening of economies after the lockdown caused by the coronavirus, the time is right to look for pockets of value in which to invest. As a recent Morningstar report suggested, there is value to be found in Singapore retail REITs.

We found that the COVID-19 outbreak has affected retail REITs the most within the Singapore REITs that we cover, and think that retail-exposed REITs are being hard-hit in the near term. However, for long-term investors who are willing to look beyond this outbreak, value emerges in these retail-exposed REITs.

As always, this article does not constitute financial advice, and investors should always invest in securities that form a part of an overall financial plan, which takes into account each individual investor’s time horizon, risk appetite, and financial goals.

With that said, let’s address some of the risks and opportunities in Singapore REITs.

Will Tenants Pay Rent?
Despite the phased and gradual opening up of economies, uncertainties around COVID-19 persist.

However, Morningstar equity analyst Ken Foong believes that the government could provide more subsidies which could help to support the economy, tenants, and landlords. “We have seen an example from the latest Fortitude Budget, which is the fourth budget this year, that was announced on May 26,” he notes. Among other things, the Fortitude Budget provides SGD 2 billion worth of cash grants to offset rental costs of small and midsize tenants.

This is a welcome move, as Foong notes that a short-term risk for REITs certainly is that if tenants are unable to pay their rents, that could result in default, while landlords would be unable to evict the said tenants for six months. But it won’t come to that, Foong feels.

“We think that the risks are minimal as retail tenants are given several months of rent free at the moment, thanks to passing through of property tax rebate, landlord rebate, the usage of security deposit to offset rent and the latest Fortitude Budget announcement. All these add up to around three months of rent free for retail tenants or around four to five months of rent-free period for small and medium enterprise retail tenants,” he says, adding that there are also security deposits of around one to four months held by the landlords which could act as a buffer.

“As for the eviction law, in cases where there are disputes (such as if the tenants were already facing cash flow issues before COVID-19), the landlord and the tenants could bring the case to the accessors which might result in the tenant being evicted,” Foong notes.

He believes that for office and industrial REITs, the risks are lower than retail REITs, as so far, rebates for these tenants are mainly from the passing-through of the property tax rebate (roughly equal to 0.3 months of rent) and the recently announced grants to small and midsize enterprises (around 0.64 months of rent) and landlords are asked to grant a similar amount of rental waiver to those SMEs that have suffered severely from COVID-19.

Other Short-Term Risks
Investors are worried that the problems caused to tenants and landlords could result in lower dividends this year, and Foong acknowledges that this might be the case.

“The regulators have allowed REITs to delay distribution by up to a year from the end of their financial year-end to distribute at least 90% of taxable income. We think that REITs (especially for the hard-hit retail-exposed REITs) could delay distribution to next year,” he says, stressing that this is a delay in distribution and not a loss in distribution. In terms of decline in underlying distribution, he thinks that the impact would be greater for retail-exposed REITs compared with office and industrial REITs, and that this affects distribution this year only.

He also believes that fears of a decrease in property valuation, which could lead to higher aggregate leverage ratio and potential needs to raise cash via equity issuance, are overblown, and the risks of this happening are low as the balance sheets of the REITs under our coverage are sound. “A point to note here is that the regulators have raised the aggregate leverage limit for REITs to 50% from 45%, giving them more flexibility. We expect available debt headroom for the seven REITs under our coverage to range between SGD 500 million to SGD 2 billion,” he says.

So it looks like short-term, investors should not be too worried, but what about longer term?

An Eye on Medium- and Long-Term Risks
In the medium term, Foong highlights two main risks: prolonged weak macroeconomic conditions due to COVID-19, which could result in companies going bust, affecting occupancy and rental rates at properties; and potential delays in finding new tenants to replace those vacant spaces.

In the long term, he points to six risks:

Decline in macroeconomic conditions;
Weak consumer sentiment and spending for retail REITs;
Unfavorable supply/demand dynamics either due to a significant increase in supply or a significant drop in demand;
Lower rental reversions;
Inability to grow the portfolio through distribution per unit accretive acquisitions; and
Increased interest rates.

Spotting the Opportunities
Foong notes that retail-exposed REITs within our coverage have also declined the most within our REITs coverage, resulting in an attractive valuation at the moment. “Besides, we also think that recovery for the retail sector could be faster (compared to the hospitality industry, for example) supported by nondiscretionary spending such as supermarket, food, and beverage and some cheaper forms of entertainment (such as arcade, karaoke, watching movies). However, in the medium term, as the macroeconomic conditions remain weak and a shift in trends to working from home, office REITs could see a higher risk. We think that risks for industrial REITs should be the least, in particularly logistics REITs,” he says.

He also thinks that the impact from e-commerce will be limited and that both brick-and-mortar and online shopping could cooperate and co-exist, pointing to examples such as Alibaba opening up a physical store in Funan; Amazon taking over Whole Foods; and Alibaba setting up Hema Supermarkets.

“This is supported by the lower shopping centre floor space per capita in Singapore compared to other developed markets, such as the US, Australia, and Hong Kong. The high population density in Singapore could also support footfall to the malls. We expect nondiscretionary and experiential shopping to be more resilient to online shopping,” he said.

REITs we like in the retail space are CapitaLand Mall Trust, Suntec REIT, and Frasers Centrepoint Trust.