UOB Kay Hian analyst Jonathan Koh is keeping his “overweight” call on the Singapore REIT (S-REIT) sector, as he sees upside from the reopening against the perceived threat against inflationary pressures.
The way he sees it, nascent signs of the easing of inflationary pressures have emerged.
“US core personal consumption expenditure (PCE) inflation peaked at 5.3% in February, the fastest pace in 30 years. Core PCE inflation eased 0.3 percentage points m-o-m to 4.9% in April,” he writes in his report dated June 3.
“The easing of inflationary pressure coincided with a pick-up in economic activities after new cases of the Omicron variant subsided. Implied inflation based on five-year Treasury Inflation-Protected Securities (TIPS) moderated from a peak of 3.6% in mid-April to the current 2.9%. The Congressional Budget Office expects CPI to ease to 4.7% in 4QFY2022 from 8.3% in April,” he adds.
The current yield curve also indicates a soft landing, which refers to efforts made by central banks to raise interest rates enough to prevent an economy from experiencing high inflation.
“We expect a series of three successive 50 basis point (bps) hikes on May 4, June 15 and July 27, followed by three successive 25 bps hikes in September, November and December,” says Koh.
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“US Fed Funds rate would thus hit 2.5% at end-2022. The yield curve inverted temporarily in April, suggesting a potential slowdown. It steepened again in May and is currently upward-sloping,” he adds. “[The] current short-end of the yield curve implies forward short-term interest rates at 2.1% for one year, 3.1% for two years and 3.1% for three years. The economy seems to be coping with external shocks.”
Commercial real estate is also a way to hedge against inflation. Landlords could raise rents to beat inflation, while higher cost of construction lowers the competition for new supplies. That said, landlords’ ability to pass on the higher rents depends on factors such as location of properties, demographics, migration trends, demand and supply dynamics and the rate of vacancies.
An appreciation in capital value could also lower loan-to-value ratio for mortgage debts, Koh writes.
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The relaxing of Covid-19-related controls in Chinese cities like Beijing and Shanghai are also “heartening”, according to the analyst in his previous report dated June 1.
Despite his positive call, the S-REIT sector is “not out of the woods yet”, although the gradual easing of inflationary pressures will provide some respite.
“In light of the elevated government bond yields and inflationary pressure potentially pushing rents higher, we have utilised a higher risk-free rate of 3.0% (previous: 2.0%) and pushed terminal growth higher by 0.8 percentage points in our dividend discount model (DDM) valuations for S-REITs,” says Koh.
“On average, we have adjusted target prices for 20 S-REITs under our coverage lower by 5%,” he adds.
He has, however, kept his earnings forecasts unchanged.
Positive on reopening beneficiaries
In his report, Koh is also recommending investors “stay invested” in the hospitality, retail and office sub-sectors as reopening plays.
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The easing of restrictions in April has seen clear benefits for the hospitality, retail and office sub-sectors.
“Hospitality REITs benefit from the resurgence and pent-up demand for travel. Tickets for Formula 1 Singapore Grand Prix in September have already sold out and MICE (meetings, incentives, conferences and exhibitions) events should pick-up in 2HFY2022,” Koh writes.
Retail REITs are also seeing upsides to the loosening of restrictions, with downtown malls benefitting from the return of office workers in the 2QFY2022 and tourists in the 2HFY2022.
Tourists accounted for 22.3% of retail sales excluding motor vehicles in 2019 (pre-Covid-19), the analyst notes.
Office REITs are also set to benefit from the reopening, with CBRE estimating rents for Grade A Core CBD offices to recover 6.9% to $11.55psf per month in 2022.
Amazon and Meta Platforms are said to be taking office space at IOI Central Boulevard Towers, which is to be completed in 4QFY2023, says Koh.
Top picks: ART, FCT, FEHT and LREIT
Among the hospitality, retail and office REITs, Koh’s top picks are Ascott Residence Trust (ART), Frasers Centrepoint Trust (FCT), Far East Hospitality Trust (FEHT) and Lendlease Global Commercial REIT (LREIT).
“ART benefits from [a] strong pick-up since March in countries with large domestic markets, such as the US, the UK, Japan and Australia. Longer-stay properties already accounted for 28% of gross profit in 1QFY2022,” says Koh.
“[FCT’s] tenant sales have surpassed [its] pre-Covid-19 levels since October 2021. Occupancy cost has eased to 16.2% in 1HFY22 (FY2021: 17.5%),” he adds.
FEHT’s aggregate leverage has dropped 4.9 percentage points q-o-q to 33.4% in the 1QFY2022 following the completion of the divestment of Central Square for $313.2 million on March 24.
LREIT had just acquired the remaining 68.2% stake in Jem. Its multi-functional event space at Grange Road Car Park is scheduled to be operational by early-2023, Koh notes.
The analyst has given these four S-REITs “buy” calls with target prices of $1.25, $2.79, 78 cents and 96 cents for ART, FCT, FEHT and LREIT respectively.
The analyst has also rated “buy” on other S-REITs such as CDL Hospitality Trusts (CDLHT), Keppel REIT with respective target prices of $1.48 and $1.41.
Selective buys for defensive and counter-cyclical yield plays
“From a bottom-up basis, we have picked three defensive S-REITs Elite Commercial REIT (EC REIT), Keppel Pacific Oak US REIT (KORE) and United Hampshire US REIT (UHUREIT) that provide attractive yields of 7.7%, 8.7% and 9.8% respectively,” says Koh.
The analyst has given all three S-REITs “buy” calls with respective target prices of 83 British pence ($1.43), US$1.01 ($1.39) and 88 US cents.
