Singapore REITs (S-REITs) are “feeling the chills” of higher interest rates once again, say DBS Group Research analysts Geraldine Wong and Rachel Tan, after US Federal Reserve chief Jerome Powell signalled greater hikes ahead last week.
S-REITs face near-term price pressure, add Wong and Tan in a March 14 note. “Our call to ride the early-year rally in S-REITs in expectation of a pause in Fed rate hikes in 1Q2023 has worked but now appears to be short-lived, as recent macro datapoints, [such as] inflation and job numbers in the US, came in hotter than expected, despite a barrage of aggressive rate hikes in 2022.”
This has prompted the Fed to turn more hawkish, guiding for more rate hikes to come with the aim to tame inflation further. In response, US treasury yields spiked by close to 50 basis points (bps) m-o-m in March 2023, with the US yield curve at its steepest inversion of 100 bps, implying heightened recessionary risk.
At home, Singapore interest rates rallied and are likely to stay higher for longer, resulting in a recent correction in S-REIT prices, say Wong and Tan. “Despite the near-term downward bias in prices, we remain optimistic that the weakness will be short-lived, as we are at the tailend of the current cycle of Fed rate hikes.”
Higher interest rates could constrain growth and consumer spending, say the DBS analysts. They prefer resilient suburban and industrial S-REITs, adding that hospitality S-REITs remain a “dark horse” with the office subsector seeing rising risk from a macro slowdown.
That said, DBS believes that interest rates are substantially priced in and investors’ focus will gradually shift to the impact of a prolonged high-interest rate environment and slower economic growth.
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They prefer China’s reopening beneficiaries, such as Mapletree Pan Asia Commercial Trust (MPACT) N2IU , CapitaLand China Trust (CLCT) AU8U and CapitaLand Ascott Trust (CLAS) HMN , with target prices of $2, $1.45 and $1.30 respectively.
As focus shifts to the impact of a recession, DBS believes that suburban retail names, such as Frasers Centrepoint Trust (FCT) J69U and LendLease Global Commercial REIT (LREIT) JYEU offer better relative distribution per unit (DPU) resilience with the capacity for upside surprises. DBS sees target prices of $2.60 and $1 for FCT and LREIT respectively.
According to DBS, the same can be said for industrial names CapitaLand Ascendas REIT (CLAR) A17U , Mapletree Logistics Trust (MLT) M44U and CapitaLand India Trust (CLINT) CY6U , with target prices of $3.40, $1.80 and $1.50 respectively.
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Which subsectors will see sustainable growth?
In the midst of a global economic slowdown, the Singapore economy remains a bright spot and is expected to post a growth rate of 2.2% in 2023, according to DBS economists.
In the S-REIT space, DBS says it “remains comforted” that overall operational fundamentals are tracking expectations. “We see a two-year DPU compound annual growth rate (CAGR) of 3.0% (-0.5% if we exclude hospitality S-REITs) over FY2022-2024, dragged by the impact of higher refinancing rates and forex losses for selected S-REITs.”
Wong and Tan add that at this point, with forward guidance generally positive, they remain comfortable and do not envision further cuts to their FY2023 forecasts.
That said, higher operating costs and interest rates will weigh on economic growth and consumer spending, write Wong and Tan. “Higher interest rates compound the ongoing inflationary pressures that are felt by most subsectors where higher utility costs are putting pressure on margins, although most of these pressures are widely known and priced in.”
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Retail and industrial names saw the highest impact to their net property income (NPI) margins in 2022, but are now seeing signs of stabilisation, say the DBS analysts.
“Most S-REITs posted declining NPI margins across 2022, as heightened costs came to light towards 2H2022. We note that the industrial (including European industrials) alongside the retail subsector saw the largest decline h-o-h in NPI margins, at -1.6% and -7.5%, respectively, while the office and retail subsectors remained most stable.”
This is driven largely by higher utility costs, which will likely weigh on margins in 2023, but the increase in service charges will help bring relief against the margin compressions seen in 2022, they add.
In the industrial subsector, acquisitions are set to support future growth, with costs shielded by triple net leases, say Wong and Tan. “The industrial subsector was the first subsector to post a DPU recovery in line with pre-Covid-19 levels, or a 2019 basis, which was also a function of accretive acquisitions across the past few years.”
While 2022 was a strong rental year for the subsector, DBS believes that onstream supply will see moderating rental growth prospects in 2023.
Rising costs, however, will be partially sheltered by high pass-through rates to tenants within the business park, high-tech and data centre assets.
Finally, topline rental growth still supports reopening sectors, say Wong and Tan. “Office was supported by record-high office rents in 2H2022, which we believe was when growth rates peaked. In 2023, we turn more cautious, given the more modest economic outlook, coupled with shadow space risks if we see a return of space from the technology tenants.”
