Within the REIT sector, MBKE sees growth potential among industrial REITs, compared to retail and office REITs. MBKE believes that industrial REITs are buoyed by demand and supply factors, a shift towards a supportive macro trend and inorganic growth opportunities.

In part one of this two-part series, we bring out the three top reasons why industrial REITs deserve to be an addition to your portfolio.

We’ll be covering some merits of some REITs worth considering in the second part of this series, stay tuned.

1. Easing of supply indigestion

The industrial REIT sector has been experiencing an increase in the supply of industrial buildings since 2014. According to MBKE, the surge in supply completion is likely to peak nearing to the end of 2017 as Singapore approaches the tail of the 2014 supply upcycles.

Upon the completion of several industrial sites at the end of 2017, MBKE notes that only two million square metres (sqm) remain in sight for completion until 2021. However, MBKE warns that not all industrial spaces are experiencing the same easing of the supply glut.

In particular, the supply outlook for factory and warehouse spaces remains challenging, in comparison to business park spaces.

2. Healthy manufacturing activity to drive demand

Another key factor in the outlook for industrial spaces is the demand for industrial spaces. Historically, demand for industrial space has strongly correlated with the strength in the manufacturing sector, making manufacturing activity a leading indicator of demand for industrial spaces.

MBKE highlights that the net take-up for factory space usually lags industrial production by a year. Thus, the continuous expansion of Singapore’s manufacturing sector for the seventh consecutive month in March is an encouraging sign of the future demand for industrial spaces.

3. Opportunities in Singapore’s shift towards manufacturing for the new economy

Apart from near-term support from stronger manufacturing activities, the Singapore government is also shifting its economic focus towards higher value-add businesses based on the Committee on the Future Economy (CFE) report.

The government is continuing to push initiatives to better position Singapore’s industries to maintain Singapore’s manufacturing base at 20 percent of GDP over the medium-term. This move involves prioritising new economy industries (e-commerce, technology R&D, data centres) over traditional manufacturing activities.

Analysts at MBKE sees this as a boon for industrial REITs in the long run. MBKE believes that this will “shift industrial space needs towards hi-specs factories and business parks over the longer term”, which underlines the attractiveness of business park spaces in the medium term.

MBKE foresees a “potential remodelling of existing landbank, leading to further redevelopment opportunities for the sector” under the government’s push for the new economy.

Industrial REITs can then leverage on the shift towards the new economy with build-to-suit (BTS) facilities and AEI projects, which will eventually drive longer term gains on the “gross floor area (GFA) boost, and rental and valuation uplifts”.

Investors takeaway: Focus on large cap industrial REITs

Acquisition opportunities to drive inorganic growth

Moving forward, industrial REITs can rely on their inorganic growth levers (acquisitions and asset rejuvenation initiatives) to drive net property income (NPI) growth. Regarding acquisitions, MBKE foresees greater acquisition opportunities for industrial REITs than retail or office REITs because industrial REIT transactions are much more manageable.

MBKE explains that industrial REITs have already announced and completed a whopping 30 acquisition transactions in the past 24 months.

Large-cap REITs

In particular, MBKE recommends focusing on large-cap industrial REITs. These larger REITs have ageing assets and sufficient debt headroom to position themselves in capturing asset rejuvenation opportunities (i.e. AEI). They could also benefit from the new development capacity (25 percent) specified by the MAS in July 2015.

Another reason why MBKE recommends large-cap industrial REITs is because of the portfolio they possess. Large-cap industrial REITs have larger asset bases that mitigate portfolio and tenant concentration risk. Their asset bases improve their credit quality, enabling larger REITs to command lower funding costs.

As such, there is the cost of capital advantage that could allow larger REITs to make yield-accretive acquisitions of small-cap industrial REITs. Based on MBKE’s analysis, valuation discrepancies between the large- and small-cap industrial REITs are currently at their widest post-GFC.

The second part of this two-part series covering the merits of some REITs worth considering will be published next Monday (8 May 2017), so stay tuned!