Is the Singapore Real Estate Sector Turning Around?

• Latest domestic property indicators still display weakness, suggesting that the market segment remains soft
• Despite this, Singapore-listed property developers have turned in stellar performances this year (as of 7 Apr 17), contributing to the bulk of suggesting that investors are looking beyond the current weakness towards more optimistic times
• Earnings for real estate developers have also been decent; mid- to large-sized developers have utilised geographical diversification to various degrees of success to insulate themselves from domestic market weakness
• Despite the weak domestic lease environment, Singapore-listed REITs have also performed admirably; industrial REITs have been some of the outperformers
• Real estate developer bonds have also done well in 2017; retail real estate developer bonds from Aspial and Oxley are amongst the sector's outperformers
• REIT bonds have also fared well; higher-yielding REIT bonds outperformed YTD

Domestic property indicators still weak

Last week (3 Apr 17), the Urban Redevelopment Authority (URA) released a flash estimate of the private residential property price index for the first quarter of 2017, reporting a quarter-on-quarter fall of -0.5% for home prices in Singapore, the 14th consecutive quarter of declines. While the price declines have moderated somewhat compared to past quarters (3Q 16 registered the largest Q-o-Q fall, at -1.5%), we note that tepid domestic economic growth is expected to continue to weigh heavily on this segment, with the consensus view that prices are unlikely to stage a quick turnaround despite the recent relaxation of property measures in Budget 2017, which made adjustments to the Sellers' Stamp Duties and the Total Debt Servicing Ratio framework.

Apart from the prices of the private residential segment, other indicators also point to continued weakness in the local property market. While we await the full real estate statistics for Q1 17 to be released by URA later this month, as of end-Dec 16 prices of other property segments have remained soft (see Chart 1), with prices trending downward since its peak in 2013. Correspondingly, vacancy rates for various segments have lingered at elevated levels compared to 10-year averages on the back of increased supply in recent years along with weaker demand and leasing activity. Specifically, according to data from URA (See Chart 1), the vacancy rates for private residential, office, retail and industrial property in Singapore was reported at levels of between 7.1% - 11.1%.

Chart 1: Property price index by property type

Chart 2: Vacancy rates by property type

But Singapore-listed property developers turn in strong year-to-date performances

It's generally understood that the stock market serves as a discounting mechanism - the forward-looking nature of the stock market is also reinforced by the use of dividend discount models based on expectations of future cash flows to derive the value of each company (stock price movements are even used as an input in the Conference Board's “Leading Economic Index” for the US). Consequently, despite the continued weakness observed in domestic property prices alongside elevated vacancy rates, it may be interesting for investors to note that stock price performance for the sector is perhaps suggesting that better times lie ahead - Singapore-listed property developers have staged a strong rally over the first quarter of this year, accounting for much of the sector's price gains over the past 12 months (Table 1).

Table 1: Top-performing Singapore real estate developers

Seasoned Investors may be familiar with the volatile earnings that are symptomatic of real estate development companies, with the bulk of revenue recognition for these companies typically occurring only at the later stages of development projects, resulting in some “lumpiness” of reported revenues and profits. We note, however, that the latest earnings releases have largely been healthy on the back of looming project completions, acting as a positive catalyst for the prices of these developers, which have been recently trading at relatively cheap valuations. As of end-Dec 16, the average price/book value of major Singapore-listed developers was just below 0.7x compared to the current 0.81x (as of 7 Apr 17), suggesting that investors were pricing in a more subdued return on equity for companies within this sector. Some notable top performers include Yanlord Land Group, Bukit Sembawang Estates, Oxley Holdings, City Developments and Capitaland.

These developers have been a beneficiary of diversification, with the prominent larger-cap property developers taking steps in recent years to diversify their development portfolio away from Singapore by securing new development projects overseas due to a series of cooling measures that were put in place on purchasing residential properties here, as well as shifting its business to generate recurring income from commercial property investments and fund management. This has insulated them from some of the negative effects from the subdued conditions in the local property market.

Singapore REIT sector remains resilient despite challenging lease environment

As alluded to in Chart 1, vacancy rates across different property sectors remain at elevated levels, which have brought about investor concerns over whether local REITs can maintain or grow their distribution rates in the face of weaker fundamentals. Macroeconomic conditions are also challenging, with the US Federal Reserve likely to further raise interest rates over 2017 which bodes poorly for the performance of REITs.

Like their real estate development company peers, Singapore-listed REITs have also defied the current difficult lease environment, with the sector delivering a sizable price gain of 7.1% YTD (as of 7 Apr 17, see Chart 3), with some of the better-performing REITs in the index being ones primarily owning industrial assets such as Sabana Shariah REIT and Ascendas REIT, which have increased 32.9% and 11.5% YTD respectively.

Table 2: Top-performing Singapore REITs

Chart 3: FTSE Straits Times REIT Index

Real estate SGD bonds posted decent returns on the expected improvement of issuers' credit profiles

How then has this improving real estate sentiment affected the SGD real estate bond market?

We've observed that the decent financial results from companies in this segment and strong stock market performance have also spilled over to the performance of their debt securities - we note that SGD-denominated bonds from Singapore developers have posted strong YTD returns (as of 7 Apr 17, see Table 3). While the improved credit profile of issuers on the back of stronger earnings and lower leverage (gross debt is reduced as project loans are repaid) have certainly provided a boost to the prices of its bonds, macro factors have also contributed to its YTD returns, with the benchmark SGD swap curve declining between 17-44 bps over the period - consistent with the recent strengthening of the SGD against the USD; reducing domestic borrowing costs - and providing support to the prices of SGD-denominated bonds.

Selected real estate retail bonds have delivered some of the best returns

On a year-to-date basis, some of the best-performing names in the SGD real estate bond space include the retail bonds from Aspial Corp and Oxley Holdings. Aspial's retail and wholesale bond tranches have posted some of the strongest YTD price returns, with the ASPSP 5.250% 28Aug2020 Corp (SGD) - Retail and ASPSP 5.300% 01Apr2020 Corp (SGD) - Retail delivering YTD price gains of 7.2% and 6.5% respectively, while the wholesale ASPSP 5.050% 12Jun2019 Corp (SGD)s returned 6.0%, narrowing the valuation gap between the wholesale issue and its two retail bond tranches, a phenomena we highlighted in a previous article (see: Is there an unrecognised opportunity in Aspial Corp's bonds?). Oxley's retail bonds also posted decent gains over the period, with the less liquid OHLSP 5.150% 18May2020 Corp (SGD) - Retail bonds posting a 6.4% YTD return and now trading at 99.14 - close to our  prior estimate of the 99.73 “fair” value of the bond back in September 2016 (See Oxley Holdings Ltd: High Yield Retail Bond Opportunity?). In comparison, the broad SGD high-yield bond segment posted a YTD price return of just 4%.

Although the returns of these bonds have been relatively modest compared to the returns on the issuer's equity prices, investors should note that over 2H 2016 these bonds were trading at up to 10% discounts to par, offering investors higher yields, which have since narrowed by 100-200 bps YTD.

Table 3: Top-performing SGD bonds from Singapore developers

Table 4: Top performing SGD REIT Bonds

REIT bonds also delivered decent returns

Compared to their real estate developer counterparts, the returns of SGD REIT bonds have been more muted, however (see Table 4), with the top performing bond being the LMRTSP 4.100% 22Jun2020 Corp (SGD)s, which have returned 4.4% YTD (Table 4). The issuer Lippo Malls Indonesia Retail Trust, which operates a portfolio of retail malls in Indonesia, recently reported a strong fourth quarter and full-year FY16 results, with distribution per unit increasing by 10% y-o-y for FY16 underpinned by positive rental reversions as well as contributions from recent acquisitions in 2015 (Palembang Icon and Lippo Plaza Batu). Its LMRTSP 7.000% Perpetual Corp (SGD)s also made the list of top performers, returning 3.1% YTD.

Other notable bonds that have performed well on a YTD basis are Sabana Shariah REIT's SSREIT 4.500% 24Sep2017 Corp (SGD)s and SSREIT 4.250% 03Apr2019 Corp (SGD)s, which recovered from a low of 97.1 and 93 respectively in January as the bonds sold off over the later part of 2016 on the back of a recent unitholder revolt over the poor performance of the manager, which is still on-going. Despite the uncertainty over the REIT's management, investors may have identified value in the bonds after the sell-off, driving the strong rebound in the bond prices.

Is there still value in the segment?

Following the decent gains seen so far for real estate developer and REIT bonds, yields in the segment have correspondingly declined, indicative of lowered levels of returns for investors. Is there still any value to be found? In Our Top SGD Real Estate Bond Ideas, we identify some of our best investment ideas in the SGD real estate bond segment at this juncture.