Morningstar Magazine - August/September 2018 - 29

and potential earnings catalysts ahead for vertically
integrated industrial heavyweight Goodman
Group GMG:AU and Ryman Healthcare RYM:AU,
though they are now fairly valued.
This lack of attractive valuations results from a
combination of property of all classes trading
at record low yields and an outlook for bond yields
to rise. Higher bond yields will weigh on the value
of listed property because of a range of factors.
First, yield-focused investors will rotate out of the
asset class to bonds, causing selling pressure.
Second, valuers will reduce their assessment of
property values as they increase the discount rates
implicit in their valuations. Third, higher borrowing
costs will weigh on cash flows and hence
on REITs' long-term distributions. Our central
scenario is for bond yields to rise over a protracted
period, but sector and property values are
particularly susceptible to a sharp rise, which
could be triggered by dislocation in credit markets.
Negative media attention in June 2017 hurt Aveo,
but we think the firm has been oversold.
The retirement living industry has very favorable
underpinnings of limited supply and sharply
increasing demand over the next five years. Aveo
also stands to generate solid redevelopment
gains as it upgrades and then resells units in older
villages. There are risks: Its reputation has
not yet fully recovered from the bad press coverage,
and it may have to trim prices if Australian
dwelling prices retrace further.
Global demand for industrial property is perhaps
the strongest it has ever been, as wholesale
investors clamor to increase their weighting to this
once out-of-favor subsector. The escalation
in demand is being driven by institutions' rotation
away from retail shopping centers toward
modern logistics facilities serving high-growth
Internet retailers like Amazon.com AMZN.
Goodman Group is particularly well placed to
benefit from the heightened interest in
industrial as it focuses on warehouses
in strategically important locations. Demand
for these is robust as they enable logistics firms
to steal a lead on competitors in speed of
delivery and cost. Goodman is already reaping
rewards from its focus on premium logistics

assets, with the portfolio having very low vacancy
and superior rent growth. Goodman also
has a series of potential earnings catalysts ahead,
including an acceleration in the volume
of development work as it becomes more active
in North America and Brazil. As most of the
developed assets will be acquired by Goodmanmanaged funds, we foresee strong uplift in
fund management earnings from an expanding
asset base and an acceleration in performance
fees. The firm has negligible gearing and undrawn
debt and equity of AUD 10 billion, providing
ample capacity to acquire quality assets should
there be a retracement in property values.
Tony Sherlock is a senior equity analyst with
Morningstar Australia.

Singapore Real Estate
Trusts Look Abroad
ASIA

Singapore
Office rental rates troughed in the first half
of 2017 and continued to recover into the
first quarter of 2018, with average monthly rental
for Grade A office space increasing by 8.4%
to SGD 9.70 per square foot. We expect the worst
to be over as new office supply is slowly
digested by the market and there is limited
new office supply from 2018 onward.
The office rental recovery should continue for the
next few years. However, this won't flow
through to the rental reversions for CapitaLand
Commercial Trust C61U:SG, the main office
REIT under our coverage. Negative rental reversion
is expected this year as average expiring rents
in 2018 are above the current average market rent
for Grade A office space. We remain positive
on the Singapore office property sector in the
long term and we expect strong regional growth to
underpin office demand from multinational
corporations, absorbing the new office supply.
In view of limited investment opportunities in
the Singapore Grade A office space market,

CapitaLand Commercial Trust made its first foray
into overseas markets by acquiring a 94.9%
stake in Gallileo, a Grade A freehold commercial
property in Germany. This transaction provides the
trust with an opportunity to diversify into foreign
markets and acquire a freehold asset. The trust
also managed to take advantage of the current low
interest-rate environment in Germany. In the
industrial property space, Ascendas Real Estate
Investment Trust A17U:SG has also stated it is
looking at investment opportunities in the United
States and Europe. We think that the trusts' active
portfolio management and overseas diversification are the right strategies going forward as
these will help to drive growth for the trusts.
Within our Singapore REIT coverage, we prefer
CapitaLand Mall Trust C38U:SG, as the trust
is trading at the largest discount to our fair value
estimate with a price/fair value ratio of
0.90. We believe that active portfolio management,
ongoing asset enhancement initiatives, adaptive
technology advancement, and redevelopment
of its properties will generate long-term growth for
unitholders. In the medium term, growth
will be supported by the redevelopment of Funan.
Of the two pure-play developers we cover, City
Developments C09:SG has more exposure to
the residential property market in Singapore. That
has been the main driver of its outperformance
relative to CapitaLand C31:SG over the past
two years. CapitaLand has prudently participated
in land auctions in Singapore and reduced its
exposure to residential development as prices
declined. However, the property conglomerate will
benefit from rising regional growth, higher
disposable income, and consumption growth in
Asia, notably in China, where it has a large
portfolio of properties and a residential property
development business. Its mall portfolio and
office investment properties are high quality,
benefiting from efficient scale. With CapitaLand
and City Developments trading at similar
discounts to their fair values, our preference is for
CapitaLand given its higher-quality portfolio.
Michael Wu, CAIA, is a senior equity analyst with
Morningstar Asia, based in Hong Kong.
Ken Foong, CFA, is an equity analyst with Morningstar Asia,
based in Singapore.

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Table of Contents for the Digital Edition of Morningstar Magazine - August/September 2018