Current outlook of S-REITs

Real Estate Investment Trusts (REITs) in Singapore are struggling for the first time since CapitaMall Trust, the first S-REIT, was listed in July 2002. Before the US sub-prime crisis took its toll on the economy and property market in Singapore.

Like their Asian peers, S-REITs have taken a beating since mid 2008. S-REIT prices have fallen by an average of 61% between end 2007 and 2008. Their total market capitalisation has plunged by 42%. With a total debt of over S$4.9 billion maturing in 2009 and more than $3.2 billion in 2010, refinancing has become the most imminent challenge, exacerbated by increasing cost of financing under the tighter credit conditions. Deleveraging is also among the top priorities of S-REITs, leading to CapitaMall Trust (CMT)’s major rights issue in March 2009. On top of these problems, S-REITs are threatened by falling rental income in all sectors and asset devaluation in their portfolios.

The retail S-REITs are expected to be the least impacted by falling rents among other S-REITs in this downturn. During previous downturns, the retail sector was the most resilient with rents declining the least. S-REITs with more suburban malls in their portfolios would face the least drop in rental income as their resident catchment would still need to eat and drink and purchase basic goods and services. Average rents in suburban areas dropped only marginally by 1.6% in the first quarter of 2009 from the peak in the third quarter of 2008 while average rents fell more by 6.9% in Orchard/Scotts Road and 3.8% in Other City Areas during the same period. Suburban malls also have an advantage over malls in the central areas in terms of competition level as among the 2.9 million sq ft of new supply in 2009, only 9% will be in the suburban areas. With the opening of Tampines 1 Mall in early April 2009, there will be no other major new mall in the suburban areas for the rest of the year.

S-REITs in the office sector would face the most impact on rental income as office demand is more correlated to GDP performance than other property sectors. During the Asian financial crisis, rents of prime office space in Raffles Place dived 41.4% from the peak in the fourth quarter of 1996 while prime first-storey retail rents in Orchard/Scotts Road and first-storey industrial rents fell less by 28.6% and 34.5% respectively. Following the Internet bubble burst in 2001, prime office rents in Raffles Place plunged 45.6%, higher than the fall of 38.9% for first-storey industrial rents while rents of prime retail space in Orchard/Scotts Road remained stable. In this current downturn, prime office rents in Raffles Place had fallen by an average of 36.8% from the peak in the third quarter of 2008 by the first quarter of 2009.

With a higher percentage of supply in the pipeline compared with other sectors, the office sector is expected to take a longer time to bottom than the other sectors. Office occupier demand is expected to be negative in 2009 with excess space caused by consolidation of operations and job layoffs. At the same time, there will be a substantial amount of new space in the next five years, the bulk of which will be in 2009 and 2010. The annual average supply of 2.2 million sq ft during 2009 to 2013 is 47% higher than the past ten year’s average.

Gauging the market through equity risk premium

Following the stock market rally since mid-March, STI has now breached the 200day MA level on the back of rising volume. I would say that the majority of stocks regardless of size, have rebounded off their lows. All technical signs are pointing towards a bullish uptrend.

In this posting, lets take a look at what the equity risk premium (ERP) is indicating for the Singapore market. To calculate the ERP, the average P/E of the index stocks are needed. Curently there are 30 component stocks which make up the STI. Based on their Y2008 earnings and the closing price on 8th May, the average P/E is found to be 10.9. Take note that 2 companies have got no P/E as they are loss-making.

The second input we need is the average 1-year fixed deposit rate of the 3 local banks. A quick search on the internet will provide the rates and the average i get is 0.55%. Using the average P/E and average FD rates, the ERP is found to be 8.63%.

One thing i would like to point out is that the ERP value is never static. It changes everyday due to the fluctuation of stock prices. Generally, a high ERP value (>2) indicates that the investor expects a higher return for putting his money into equities especially during periods of uncertainty. In order to make investing in equities worthwhile, the investor must be adquately compensated through earning higher returns. On the contary, it goes down when investors are bullish about the future prospects of equities.

The current ERP of the STI is relatively high as compared to one, two years ago. As such, the Singapore market is not considered to be expensive. However, bear in mind that trailing P/E is being used. A 20% drop in earnings this year for market is not far-fetched. As investors, we should never rely on a single metric to determine our buy or sell decisions. Even though the Singapore market is not expensive, whether it can still continue to go up is anyone's guess.