Although the US Federal Reserve’s (Fed) guidance of tighter monetary conditions is restricting Singapore REITs (S-REITs) near-term re-rating potential, DBS Group Research analysts do not see major retracement in prices as the negatives are already priced in.
In their Oct 2 note, analysts Derek Tan, Dale Lai, Geraldine Wong and Rachel Tan point out that the recent hawkish comments from the Fed and a reversal of rate cut expectations in 2024 remains a near-term dampener.
On rising investor expectations that interest rates are likely to remain stickier than normal, S-REITs endured a weak September. The FTSE ST Real Estate Investment Trusts Index is down about 3% last month, underperforming the Straits Times Index which is similarly down by about 1.5%. AT the current levels, share prices imply a FY2024 yield of about 6.4%, the analysts point out.
While interest rates remain the key constraint for DPU growth, DBS believes its FY2023 to FY2024 DPU growth forecast of about 2% sufficiently prices in most of this risk.
To this end, the analysts maintain its stance of preferring sectors with resilience and visibility that can withstand a potential recession, as well as S-REITs with stronger shields against an extended period of “red hot interest rates”.
They like suburban retail trusts such as Frasers Centrepoint Trust J69U and Lendlease Global Commercial REIT JYEU ; and industrial trusts such as CapitaLand Ascendas REIT A17U , Mapletree Logistics Trust M44U and CapitaLand India Trust. DBS is also keeping an eye on hospitality REITs such as CapitaLand Ascott Trust which could surprise on the upside.
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Meanwhile, the analysts remain cautious on the office subsector, preferring office S-REITs with a retail component such as Mapletree Pan Asia Commercial Trust.
While investors have focused on S-REITs’ debt expiry profile to get a sense of the refinancing pressures that S-REITs face, DBS analysts say they are comforted that only about 5% and 17% of overall debt is to be refinanced in FY2023 and FY2024, respectively. With hedge ratios still remaining fairly high at close to 75%, the increase in interest rates is likely to be somewhat constrained, they add.
That said, the analysts also cast their eye on the $5 billion perpetual securities market, which has been an effective tool in the past few years for S-REIT managers to widen their capital structure by tapping fixed income-based investors who are lured by the higher yields compared to normal debt.
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A key datapoint to watch is the reset dates or call dates for these perpetual securities, most of which will come up in 2024 to 2025, the analysts highlight. While most of the perpetual securities are expiring only from 2025 onwards, the analysts believe that interest rates then should be lower than the current levels. DBS’s sensitivity analysis shows that every 1% decline in base rates could reduce dilution of FY2025 DPUs by 1.1%.
With the risk of gearing inching higher in the face of possible asset devaluations and interest coverage ratio pressure, DBS analysts see S-REIT managers continuing to pursue deleveraging strategies through asset sales and potentially pursue equity raisings, if market conditions allow.
The analysts believe that an equity fund raising may not be as dilutive as what the market perceived with high debt costs in the range of 4.5% to 5%. As such, they estimate that the “opportunity costs” between raising new equity and new debt has compressed to close to historically lows in 2023, suggesting that issuers, at the right market conditions, may look to tap equity markets to optimise their overall capital structure.
