Analysts are remaining cautious on the prospects of Singapore REITs (S-REITs) amid the rising volatility in interest rates.
RHB Group Research analyst Vijay Natarajan has downgraded his sector rating to “neutral”, down from “overweight” as he expects the volatility to persist in the near term. As such, he also expects the unit prices of S-REITs to be “range-bound”.
“As Singapore adopts monetary policy, its benchmark interest rates are closely correlated to the US’ Federal Funds Rate (FFR),” he explains.
The RHB Economics team has forecasted that the US Federal Reserve (US Fed) will continue hiking its rates in March, with a peak of 5.25% to 5.5% and no cuts in 2023.
“As S-REITs are considered as yield instruments, its performance is highly sensitive to the interest rate curve,” the analyst adds.
One of the effects of the rising interest cost pressures is the flattish distribution per unit (DPU) growth for the FY2023 to FY2024. Among the sub-sectors, Natarajan sees the hospitality and industrial S-REITs being the sector’s “key growth drivers”.
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“DPU outlook is mainly weighed down by rising borrowing costs, which have risen (sector average) by 60 basis points (bps) since 2HFY2022, and are expected to rise by 75 bps - 100bps this year, as the full effect of rate hikes gets transmitted,” he writes.
“This is despite S-REITs having a good hedge profile of [around] 73% of debt. On the other hand, cost pressures have likely peaked, as utility costs – a key contributor to higher expenses last year – have normalised, and most S-REITs have adjusted service charges to offset inflationary pressures,” he adds.
Despite the downgrade, Natarajan notes that S-REITs remain operationally resilient with most of the REITs guiding for positive rent reversions to continue in FY2023 albeit at a slightly lower pace. The guidance ranges from low to mid-single digits, the analyst notes.
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During the FY2023, Natarajan expects industrial S-REITs to maintain their high occupancy levels while office and retail S-REITs are likely to see some fluctuation in their occupancy levels amid softening demand albeit remaining “well supported by limited supply”.
“Unsurprisingly, Singapore asset values have held steady with slight increases in hospitality, office, and logistics assets. On the other hand, overseas portfolios (particularly the office sector) have seen a drop in value. Looking ahead, we expect a modest cap rate expansion (5 bps - 25bps) and do not expect any significant drop in asset value,” says the analyst.
Industrial subsector preferred, says RHB
Among the sector, Natarajan says he prefers the industrial subsector with valuations at “reasonable entry level for mid- to long-term investors”.
Year-to-date (ytd), S-REITs have remained flat with outperformances from healthcare and industrial S-REITs.
“We expect investors to stick to a defensive posture amid increased volatility, while industrial and healthcare REITs continue their outperformance. Overseas, office and retail S-REITs could potentially make a comeback in the second half of the year, upon normalisation of interest rates and a clearer view on the economic outlook,” he says, adding that overseas S-REITs are “trading at distress valuations and could see a sharp bounce back once the dust settles”.
Natarajan’s top picks are CapitaLand Ascendas REIT (CLAS), AIMS APAC REIT (AA REIT), and Keppel REIT.
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S-REITs ‘not out of the woods’ despite retreat in US 10-year yields
S-REITs are still “not out of the woods” even after a retreat in the US 10-year yields as refinancing spreads remain positive, say DBS Group Research analysts Dale Lai, Derek Tan, Rachel Tan and Geraldine Wong.
The US/SG 10-year yields have seen “heightened volatility” of late at the US Fed’s previously hawkish stance in its interest rate outlook for 2023 was tempered by the recent troubles at Silicon Valley Bank (SVB) and Signature Bank. The yields are now some 30 to 40 bps off its recent peak at around 3.6% / 3.0% as at March 15, the team notes.
Following the collapse of the banks, the markets are now expecting the Fed to turn more cautious on further rate hikes to alleviate the balance sheet stress seen in the banking sector due to its aggressive hike stance, notes the team.
Despite the “recent mixed data” emerging from the US, the economists at DBS still estimate the Fed’s terminal interest rate of 5.25% in 2023 with two more 25 bps rate hikes till May.
If their predictions are accurate, this would mean that the rate hike cycle is at a “tail-end” with an earlier-than-expected pause likely to drive a near-term re-rating of S-REITs. The observation is based on the last rate hike cycle in 2015 to 2018 where S-REITs
“Per our observation of the last rate hike cycle in 2015-2018, where S-REITs outperformed the benchmark Straits Times Index (STI) when rate hikes stopped.
Interest rates to peak in 2H2023, says DBS
Interest rates are expected to peak sometime in the second or third quarter of 2023, says the team at DBS, with rates to gradually decline from its current levels. The Fed is expected to take its foot off the pedal and potentially cut rates in the 2H2024, the team observes.
That said, rates are expected to remain elevated compared to the interest rates in the past six to eight years.
That said, the REITs will continue to see higher financing costs in 2023 as near-term base rates (the three-month SORA, three- and five-year swaps) remain elevated at close to the 4.0% level.
SORA stands for the Singapore overnight rate average.
The higher base rates will also continue to eat into the REITs’ DPUs, the team points out.
“Assuming a three-year refinancing profile, refinancing costs will rise by [around] 2.5%-3.0% in 2023-2024 due to the difference in base rates,” the team writes.
“That said, we remain comfortable with our estimates, as we have priced the spikes in base rates into our forecasts and see defences coming from a well-spread-out debt maturity profile and an increase in the overall hedging of loans to fixed rates,” they add.
Within the S-REITs sector, the hospitality and retail (overseas) subsectors will see the most significant impact to financing costs if they continue inching up in 2023, as they have the lowest proportion of debt hedged to fixed rates.
Conversely, US office and industrial REITs will be the least impacted, given the high proportion of fixed rate hedging and minimal debt due for refinancing in FY2023, the team notes.
Should finance costs continue to increase but at a slower pace, REITs with higher gearing and a larger proportion of debt due for refinancing in the FY2023 will see a larger impact to their DPUs.
The office and hospitality segments are likely to see the biggest drop in their DPUs due to their relatively higher gearing and larger proportion of debt due for refinancing in the year.
Maybank keeps ‘neutral’ call amid macro cross-winds
Meanwhile, Maybank Securities analyst Krishna Guha is remaining “neutral” on the S-REIT sector despite the cross-winds of the US bank failures, the higher short-term interbank rates, wider credit spreads and the sharp declines in the US two- and 10-year yields.
“Singapore has seen similar moves on a smaller scale,” notes Guha. The country’s 10-year yield is down some 30 bps from last week’s peak while the three-month compounded SORA is up by 5 bps from the week before.
“[The] Singapore dollar (SGD) has reversed its rapid appreciation against the US dollar (USD) and is flat ytd. The central bank, Monetary Authority of Singapore (MAS), has said that the local banking system remains sound and resilient,” he points out, adding that his house view is unchanged.
“We expect the Fed to raise rates to 5.0-5.25% by mid-2023 and hold at that level before cutting in 2024. [The] likely peak of [the] three-month SIBOR [is around] 4.8%,” he says.
SIBOR stands for the Singapore interbank offered rate.
Guha’s top picks within the sector are CapitaLand Integrated Commercial Trust (CICT), Frasers Centrepoint Trust (FCT), ESR-LOGOS REIT, Mapletree Industrial Trust (MINT), CDL Hospitality Trusts (CDLHT), CLAS and Far East Hospitality Trust (FEHT).
