Reit Model Under Pressure

Source : The Business Times, January 5, 2009

SINGAPORE-listed real estate investment trusts (Reits) are now victims of their own success.

Sliding: CB Richard Ellis reckons that prime Orchard Road rents could contract 5-10 per cent in just the first half of 2009

Over the past three years, most Reits here have taken an aggressive growth path, snapping up expensive properties and pushing up rentals in their properties as they took advantage of the property boom. This has allowed them to increase net property incomes and deliver good dividends to their unitholders.

But now, the good times have come to an end, and it is unclear how these Reits will deliver the kind of returns shareholders have gotten used to.

When reporting their Q3 results, the Reits admitted that growth through acquisitions will slow, what with the current credit squeeze making merger and acquisitions (M&As) more difficult and expensive across all sectors. The Reits said they will look to organic growth, such as enhancing their existing lettable space in search of higher rents.

But how much organic growth there can be under these conditions is debatable.

Retail Reits, for example, increase their property incomes in three ways - from acquisitions, through rental increases after they enhance their properties, and increased sales from their tenants, which they typically take a cut of.

But now, all three avenues for property income growth appear to be blocked. Acquisition growth, as mentioned, is no longer as viable. Retail sales are expected to take a beating this year as consumers cut back on spending as concerns over job and wage security take hold. Because of this, landlords, who typically take a percentage of turnover as part of the rent, will also see takings fall.

And rents will fall, as tenants try to bring landlords back to the negotiating table to ask for more manageable rates. 'A prolonged depression in consumer spending could affect retailers' ability to service their rents and we think it is possible that more retailers would renegotiate for lower rental rates, and retail mall managers may have to give in to avoid a high turnover in tenants,' noted OCBC Investment Research in a recent report. As one market observer put it, 'Reits can't really squeeze the tenants anymore or they will just simply close shop.'

In 2009, CB Richard Ellis reckons that prime Orchard Road rents could contract 5-10 per cent in just the first half of the year. At prime suburban malls, a 2-3 per cent decline is likely, the property consultancy said. Prime Orchard Road rents fell 1.9 per cent quarter-on-quarter in Q4 2008, while prime suburban rents shed one per cent, the firm's data showed.

The same trend holds true for the office and industrial sectors. CBRE's data showed that average Grade A and prime office rental values in Singapore are estimated to have slipped about 20 per cent in Q4 2008. More falls are expected this year. Likewise, rents for industrial space could see double-digit percentage falls, analysts have said.

With retail, office, and - to a lesser extent - industrial Reits, having raised rentals quickly over the last few years, tenants are finding themselves in a tough spot during these trying times. Office rents, for example, nearly doubled in 2007, rising 96 per cent in the Grade A category and 92 per cent for prime space. That was on top of gains of 53 and 50 per cent respectively posted in 2006.

What this means is that tenants, who have been paying jacked-up rentals over the past two years, will in some cases lack the reserves to withstand the current crisis. They are also more likely to push for substantial rental decreases, which could affect the Reit model.

Jannie Tay, president of the Singapore Retailers Association, called for a drop in retail rents - in light of weaker sales - as early as September last year. Recently, she again asked retail landlords to cut rents by between 30 and 50 per cent. Reits are going to face pressure to give in.