SINGAPORE (Feb 14): Singapore REITs (S-REITs) have consolidated following a strengthening interest rate outlook over the past week, returning YTD gains, according to Deutsche Bank Markets Research.
In a Tuesday report, analyst Joy Wang says, “While headwinds from rising rates remain, we highlight the lack of correlation between 10-year rates and REIT performance over the past 2 decades. We believe that the recent pullback offers a good entry point for REITs with a strong growth outlook.”
The research house’s top “buy” picks are CapitaLand Commercial Trust (CCT), Keppel REIT (KREIT) and Mapletree Logistics Trust (MLT), with target prices of $1.90, $1.30 and $1.35.
On the back of a positive outlook on the Singapore office sector, Wang has upgraded her recommendation on CCT and KREIT to “buy” and raise 2020 rental growth slightly to 2-3% from 0-2% previously.
CCT and KREIT have underperformed YTD by 6% and 12% respectively. Market expectation and consensus DPU have also been lowered to a realistic level.
Both the REITs valuations have become more attractive, according to Wang, after the pull-backs, implying below $2,200 psf for Grade A office space.
Consensus has expected three rate hikes by the Fed this year and subsequent steepening of the yield curve, which have caused S-REITs to return much of the gains achieved at the start of the year.
“Nevertheless, we note that yield spreads and price to book valuations have only recently reached historic averages after trading at discounts since 2015,” says Wang.
Looking ahead, the analyst believes that the key differentiator for REITs in a rising rate environment will be an ability to grow dividends and maintain yield spreads.
While assets remain tightly held, accretive acquisitions will be easier for REITs that trade at a premium to book value, leading to higher growth and in turn lower costs of capital, turning a virtuous cycle.
On the other hand, Wang believes that asset yield for office REITs remain prohibitive for domestic acquisitions, and see a potential for asset recycling, given premium valuations in Singapore compared to higher-yielding overseas sponsor pipeline assets.
Given the diversity between prime destination and specialty suburban malls, the analyst also believes that the acquisition landscape for the domestic retail segment remains marginal.
In previous cycles, S-REITs traded at low yield spreads of about 96 basis points (bps), while price-to-book (PB) valuations were high at 1.72 times in early 2007.
“More recently, we note that yield spreads have compressed to as low as 339bps vs. 359bps currently, and as high as 1.25x P/B in 2015 vs 1.08x P/B currently. We note that since 2010, SREITs have traded within a 1-standard deviation band, while yield spreads have traded at or around their historical average,” says Wang.
As at 4.10pm, units in CCT, KREIT and MLT are trading at $1.74, $1.19 and $1.22 respectively.
