A rapid deterioration in the external sector and the economic outlook is likely to crimp demand for industrial/warehouse space amid rising new supply. We expect yields to soften by 150bp from June 2008, placing downward pressure on capital values.

Rental reversions/lease structures are likely to underpin REIT cashflows. That said, growing concerns over their ability to refinance debt have seen REITs trade below book. In such conditions, investors need to focus on underlying asset value/quality, while REITs with well-located assets should benefit from potential M&A activity.

Amid a marked contraction in both GDP (4Q08: -4.2%) and GDP expectations for FY09 (-6.3%), Ascendas REIT (AREIT) has fallen 12.9% since our downgrade (see 3 December Selected value after elective surgery) to quickly test our revised price target (it was S$1.25/unit pre rights / S$1.23post rights), compared to the STI’s index loss of 2.7% during the same period. At this point in time, the dilemma remains on whether to upgrade our call or revisit our bearish industrial property assumptions. In our view, we believe the latter is more prudent, as we expect the contraction in real demand (manufacturing job losses in 4Q08 were 6,200, the first decline in manufacturing employment since June 2003) to accelerate, with the contraction in demand likely to be manifested in worse-than-expected rental declines in 1H09.

We now look for rents to decline 31.7% over the cycle, from 23.9% previously (see below: weaker outlook for demand) and maintain our view that rising risk premiums and lower growth expectations will be reflected in a 150bp increase in industrial yields. While deferral of new supply, specifically in the warehouse market, is likely to temper the rise in vacancy, vacancy is nevertheless expected to broach 10%, with landlords bargaining position, in our view, significantly eroded. We have marginally raised our distributable income for FY10 and FY11 by 6.9% and 6.2%, respectively, with our more hawkish rental outlook offset by lower interest expenses as a consequence of the recent S$408mn capital raising. Notwithstanding the placement, we still envisage the possibility of AREIT looking to raise more equity over our forecast period to check gearing, given the probability of more asset write-downs. Our revised post-placement sum-of-the-parts (SOTP) NAV is S$1.13/unit (versus S$1.23/unit post place pro-rated), with our FY10 DPU now at 12.6S¢/unit (from 14.9 S¢/unit pre placement/offering). We reaffirm our bearish call on AREIT and envisage broad-based cuts to market target prices, as the market increasingly moves away from income based valuations (DDM) towards asset based valuations and appropriate market-based capitalisation rates are adopted. We maintain our REDUCE rating.