2023 could be a year of two halves for S-REITS, with share price weakness in the former half presenting buying opportunities, say CGS-CIMB Research analysts.
S-REITs are riding into a slowing rate hike environment, and the market has factored in 40 to 665 basis point (bps) additional rate hikes into their current share price valuations, they add. “Our stress test indicates that a 50-100 bps reversal in peak spot interest rates could lighten interest burden and lead to forward sector distribution per unit (DPU) stabilisation.”
The recovery of S-REITs is likely to be uneven, says CGS-CIMB, given the lagging impact of earnings and asset value adjustments on key financial and balance sheet metrics. “In the near term, we believe that S-REITs would face continued scrutiny on earnings and net asset value (NAV) resilience.”
In a Dec 7 note, CGS-CIMB stays “overweight” on the sector with CapitaLand Integrated Commercial Trust (CICT) and CapitaLand Ascendas REIT (CLAR) as their top picks. “The downside risk to our view is a higher and longer than expected rate hike environment that would further derail our earnings estimates.”
CICT is now trading at an FY2023 dividend yield of 5.4%. “We believe that the market may have priced in another 50-75 bps anticipated rate hikes into the current share price,” notes CGS-CIMB. The analysts maintain “add” with a target price of $2.35.
Meanwhile, CLAR boasts a diversified and resilient portfolio as well as its healthy balance sheet, say CGS-CIMB analysts. They have a target price of $2.79 for CLAR with a dividend yield of 5.8%. “NAV remains well protected with a high natural hedge of 75% for overseas investments to minimise the impact of exchange rate fluctuations. The stock is currently trading at 6.3% FY2023 dividend yield.”
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S-REITs' underperformance
The spike in interest rates and inflation concerns have led to an underperformance of S-REITs compared to the broader Singapore market since the start of FY2022. “The FTSE ST Real Estate Investment Trusts (FSTREI) Index has declined by 16% year-to-date (ytd). Based on Bloomberg consensus forecasts, we think we are closer to the end of the rate upcycle while inflation appears to be subsiding. This should be supportive of S-REITs performance in the medium term.”
S-REITs with strong balance sheets, financial metrics and low gearing are likely to emerge from this environment faster and better, say CGS-CIMB analysts. “Based on our sensitivity analysis, Suntec REIT (SUN), Lendlease Global Commercial REIT (LREIT), ESR-LOGOS REIT (ELOG) and Keppel REIT (KREIT) could face the most challenges in addressing interest coverage ratio requirements.”
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Those with higher gearing levels, such as SUN’s gearing, could be impacted if overall portfolio values dip by 5%. Those with low gearing and strong balance sheet capacity to grow include Frasers Logistics & Commercial Trust (FLCT) and Sasseur REIT.
S-REIT share prices have declined 15% ytd, with its worst m-o-m performance in October, due to expectations of a strong rate hike on stubbornly high inflation outlook.
With the sharp surge in interest rates, there was a faster than expected rise in interest costs of 20-50 bps q-o-q in 3QFY2022. That said, operating metrics remained resilient with most S-REITs enjoying stable or higher occupancy levels and positive rental reversions.
Industrial REITs delivered strong rental reversion of 3.5%-11.4% in 3QFY2022, particularly within the logistics sector.
The office sector also continued to see 5.9%-9.2% reversions amid limited new supply in Singapore.
Retail REITs rent rose 0.8%-4.8% on reversions, with downtown malls performing better in terms of tenant sales following borders reopening.
Hospitality REITs delivered a strong set of 3QFY2022 results with CDL Hospitality Trusts (CDLHT) delivering a 44% y-o-y jump in 9MFY2022 revenue.
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Meanwhile, Far East Hospitality Trust (FEHT) reported a 5% y-o-y increase as hotels benefit from a rebound in global travel.
Office and industrial REITs also indicated that they have signalled an increase in service charges (included in gross rent figures) for some of their properties from 2H2022 or from January 2023 onwards to pass on higher operating costs.
Retail REITs could pass on the cost increases when leases expire, according to CGS-CIMB.
Closer to the end of rate upcycle than the beginning?
According to CGS-CIMB’s economist, the US Federal Reserve (Fed) is likely to continue raising rates albeit on a smaller scale in early-2023.
Bloomberg consensus forecasts also peg a 50 bps hike in December and a 50 bps increase in 1Q2023 before stabilising in mid-2023. “We have used similar assumptions in our current estimates. In terms of macro outlook, CGS-CIMB economists project Singapore GDP to grow at a slower pace of 2% in 2023 due to an expected global slowdown.”
CGS-CIMB expects other external-oriented production such as precision engineering, petrochemicals, as well as marine and offshore to moderate in tandem. “On the domestic side, the consumer-facing and travel-related sectors should continue to recover in the near term, but at a more moderate pace, due to a higher base in 2022, in our view.”
A higher GST rate effective from January 2023 could moderate consumption in 1HFY2023 although it may contribute to a temporary spike in spending in 4QFY2022. CGS-CIMB projects consumer price index (CPI) to expand 4.5% in 2023 (compared to 5.1% in 2022) due to a global slowdown.
“On prices, while headline CPI may trend lower, we anticipate core inflation to remain robust through early 2023 following the strong wage growth amid a tight labour market, as well as the GST increase,” says CGS-CIMB.
How much should interest rates decline before we see a sector DPU recovery?
Average debt cost for S-REITs rose 20-100 bps q-o-q in the 3QFY2022 with the sharpest rise coming from ELOG and LREIT.
With Fed Fund rates still poised to reach a target 5% in the near term, we believe that near-term S-REIT refinancing activities should continue to see overall funding costs trending up.
“In our sensitivity analysis, we detail the potential forward funding cost for S-REITs and impact on DPU, assuming a 50 bps rate hike in 2023, on top of a 50 bps hike in December, and for rates to hold steady thereafter,” says CGS-CIMB.
CGS-CIMB also assumes that S-REITs’ debt maturity profile, percentage of fixed rate debt and the currency of debt remains unchanged vs 3QFY2022’s breakdown.
Our findings show that debt cost could rise by an average 40 bps from 3QFY2022 to 4QFY2022, 45 bps in 2023 and 20bps in FY2024. “These estimated funding costs could mean another 4%-5% per annum (p.a.) downside risk to our current DPU estimates in FY2022-FY2023 and result in a sector DPU y-o-y decline of 2.7% in FY2022 and 1.2% in FY2023 before stabilising in FY2024.”
Conversely, a 50 bps decline from CGS-CIMB’s base case assumption of a 50 bps rate hike in 1HFY2023 interest rates remaining unchanged at end-1HFY2023 compared to end-2022 level, could result in flat DPU y-o-y, indicating some stabilisation coming into the sector.
S-REITs have robust balance sheets, note CGS-CIMB analysts. “Average sector gearing was 38.5% at end-3QFY2022, still well below the 45%/50% guideline ceiling. The sector has little refinancing risk with 4% of total debt to be refinanced in 4QFY2022 and 14% in 2023. The overall proportion of floating rate debt is also low, at 25% of total S-REIT sector debt at end-3QFY2022.”
