Amid persistently high inflation rates coupled with rising oil prices, businesses are now looking at higher utilities and petrol costs, as well as labour costs. Landlords, too, will have to face higher utility and maintenance costs when their contracts are rolled over to the 2HFY2022 and FY2023.
With most Singapore REITs (S-REITs) as landlords, operational costs in maintaining the common areas, will have to be borne as well.
While some of these costs can be defrayed through service charges, landlords will still have to bear some of the burden going forward, note DBS Group Research analysts Derek Tan, Rachel Tan, Dale Lai and Geraldine Wong.
“In the most recent meetings, we see more questions surrounding the impact of higher utilities and maintenance contracts on net operating income and distributions,” they write in their report dated March 18.
“In our analysis and engagement with various companies, the spike in utilities and maintenance will indeed be an overhang but overall impact is varied and manageable,” they add. “We believe that the ability to continue growing revenues strongly at [around] 20% in FY2022 will be a key mitigator to the rise in operational costs.”
Potential impact on margins
See also: Test debug host entity
However, the analysts believe that a part of the price increases, such as oil, may be temporary due to the current geopolitical crisis and supply disruption.
“Therefore, the impact of these higher costs may be spread out over several years, depending on the timing of the expiry of the current maintenance and utility contracts”, they write.
Should utilities rise 100% and maintenance costs go up by 10%, however, the analysts have estimated that net property income (NPI) margins may be lowered by 0.8 percentage points to -3.7%, with a larger decline seen industrial-focused S-REITs due to their bigger exposure to both maintenance and utilities.
See also: Maybank downgrades ComfortDelGro in contrarian call over Addison Lee acquisition worries
The lower NPIs translate to a possible drop in distributions per unit (DPUs) of around 1.8% to 6.7%, with the warehouse sector seeing the lowest declines of c.1.8%.
Warehouse sector least affected by rise in operational costs
To this end, the analysts have identified the warehouse sector – mainly ambient warehouses – as one that will be most shielded from the rise in operational costs.
This is given the sector’s efficient footprint, in which the analysts see the least downside to earnings on the back of rising costs.
Potential impact by S-REIT sub-sectors
Within the office sub-sector, majority of the utility costs are borne by tenants, while utility costs for common areas are reimbursed via a service charge to tenants. Some office landlords could have locked in a utility rate for one to two years to mitigate the rising rates, note the analysts.
Green buildings with energy-saving features may also help reduce utility costs, they add.
For more stories about where money flows, click here for Capital Section
Within the retail sub-sector, the REITs’ utility contracts help to hedge the effect of utility hikes for up to one to two years. Furthermore, the service charge paid by tenants can be used to defray costs incurred for common areas.
In the industrial sub-sector, most utility costs are recoverable from tenants in general industrial buildings such as business parks. However, these buildings generally has more common space and services compared to other industrial property types, and will be most impacted by the rising costs.
Logistics-focused industrial S-REITs such as ambient warehouses have minimal impact as they are very space efficient and have minimal common spaces. However, climate-controlled warehouses may be impacted if utility charges are set on a fixed rate.
Data centres will also face minimal impact, as leases are either triple-net or utility costs are charged directly to tenants.
Finally, within the hospitality sub-sector, the impact is not material as they are mainly borne by the master lessor.
That said, the hike in utility costs will be more visible in S-REITs’ European and US portfolios.
“Similar to the other subsectors, some properties have secured fixed rates with energy brokers to mitigate the impact of a utility cost hike,” write the analysts. “Longer stay lodging assets typically come with a cap on utility usage whereby guests will pay if they exceed the utility cap.”
S-REITs to still be able to deliver two-year DPU CAGR of 7.4%
In their report, the analysts estimate that the S-REIT sector is still able to deliver a DPU growth compound annual growth rate (CAGR) of 7.4% (compared to 8.0%) before, with sector yields still attractive at an estimated 6.0% despite the rising cost pressures.
“Assuming the highest 3.0% cut in margins for other sectors (overseas-focused REITs, healthcare, and hospitality), we find that the growth trajectory for the sector is potentially marginally reset lower by 30 basis points, to 7.7% (ranging 2.8% to 28.0%) from 8% (ranging 3% to 30%),” write the analysts.
“As such, we remain comforted that the S-REITs’ growth trajectory remains intact for most sectors, despite the worrying trend of higher operational costs remaining an overhang for the sector in the near term,” they add. “Based on our sensitivity analysis, every 100% hike in utilities, in our estimates, will cut our DPU by 4.0% and growth trajectory by 40 basis points.”
Stick with ‘growth sectors’
On this, the analysts have recommended investors to “stick with ‘growth sectors’, given their ability to deliver higher distributions per unit (DPUs) despite these costs pressures”.
“In addition, we have added Mapletree Logistics Trust (MLT) to our top eight names.”
As at 2.53pm, the iEdge S-REIT Index, Singapore’s S-REIT benchmark, is trading 6.97 points higher or 0.528% up at 1,328.22 points.
Photo: MLT
