The US Federal Reserve, which sharply increased its inflation forecasts for 2021 on June 16, appears to be more hawkish than initially expected by economists.
The majority of the 13 members of the Federal Open Market Committee believe that the central bank will increase rates in 2023 and at least twice that year.
To the team of analysts at DBS Group Research, Derek Tan, Rachel Tan, Dale Lai and Geraldine Wong, the revised expectations of two hikes by end-2023, compared to the previous expectation of one hike by 2024, is likely to drive rates higher.
With this, the team notes that DBS’s economists project the 10-year yields to rise towards 2.0% (US) and 1.65% (SG) by end-2021, which is 25 to 40 basis points higher than the current levels, and up a further 40 to 50 basis points through 2022.
The rise in 10-year yields, which is a key relative benchmark to price Singapore REITs (S-REITs), “will be keenly watched”, says the team in a June 18 report.
“While this will be a natural overhang for S-REIT’s performance, we see a more divergent performance going forward, with a focus on growth,” they write.
While the hawkish outlook brings to mind bad memories of the 2013 taper tantrum episode, which saw a surge in US Treasury yields, the team at DBS says it does not see a repeat in the immediate term.
“This is because that the market appears to be less complacent this time around and we believe the market has largely priced in higher interest rates for S-REIT’s share prices,” they reason.
This is also due to the fact that the 10-year yields are already 80 to 90 basis points higher at the start of 2021 compared to that of the “taper tantrum days” where the 10-year yields remained anchored at low levels.
The share prices of S-REITs in 2021 are also 7% below the recent peaks, compared to the peak in the S-REIT index in May 2013 before a reset in investor expectations lowered prices significantly.
See also: S-REITs dependent on the re-opening of the economy could see near-term weakness: DBS
In addition, valuations for S-REITs this time are not stretched considering the lower price-to-net asset values (P/NAV) of 1.04 times versus the 1.15 times in 2013 with wider yield spreads supporting valuations.
On this, a “certainty of growth” will be seen as a “valued trait” among S-REITs as the world navigates through a higher inflation and interest rate environment.
The higher yield spreads in 2021 of 4.2% compared to the 3.8% in 2013 and growth profiles of 8% in 2021 from 5% in 2013 are supportive of valuations, add the analysts.
As such, they have recommended that investors keep their positions in selected retail and office REITs such as Keppel REIT, Mapletree Commercial Trust (MCT), Frasers Centrepoint Trust (FCT) and Lendlease Global Commercial REIT (LREIT).
They have also recommended investors to keep their positions in industrial REITs such as Mapletree Logistics Trust (MLT), Frasers Commercial & Logistics Trust (FLCT), ARA LOGOS Logistics Trust and AIMS APAC REIT for their certainty in growth.
Hospitality REITs such as CDL Hospitality Trusts (CDLHT) and Far East Hospitality Trust (FEHT) are the analysts’ medium-term picks on the back of the return of international travel.
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However, key risks to S-REITs include the further acceleration in rate hike expectations, as well as a reset in growth assumptions for 2021.
The analysts at DBS have rated all the REITs under their coverage (mentioned above) at “buy”.
As at 4.52pm, units in Keppel REIT, MCT, FCT, LREIT are trading at $1.18, $2.14, $2.42 and 80.5 cents respectively, while units in MLT, FLCT, ARA LOG and AA REIT are trading at $2.03, $1.40, 82.5 cents and $1.44 respectively.
Units in CDLHT and FEHT are trading $1.23 and 60 cents respectively.
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