Inflation is a double-edged sword for REITs. Inflationary pressures may keep rents high, but they could also pressure interest rates indirectly, through yields on risk-free rates such as yields on 10-year bonds both in the US and in Singapore.
Yields on 10-year US treasuries have risen to as high of 1.6%, up 70% this year, as inflationary fears triggered by the US stimulus took hold. Rising bond yields are likely to affect interest rates, and in a roundabout way, discount rates that investment property valuations rely on. Eventually, capitalisation rates are also affected.
Hence, rising yields impact REITs in three main ways — on interest rates and hence their cost of debt, and cost of capital; on discount rates and capitalisation rates, and hence REITs’ capital values; and of course the yield spread - REITs take their pricing off risk-free rates, and REIT yields can rise in tandem with risk-free rates. If yields are going to expand, then something has to give and it’s likely to be the market price of the REIT.
In a recent report, OCBC Investment Research points out that yield spreads are approaching 10-year lows. The yield spread of S-REITs and 10 year Singapore government securities is ‘approximately 0.4 standard deviations below the 10-year average’, the report says. “Valuations for the sector are no longer as appealing as compared to six months ago, and we would be cautious over the near-term as volatility is likely to stay and there could be further selling pressure. Our house projections for the 10-year US Treasury yield over the next 12 months was recently raised from 1.5% to 1.9%, and we note that the correlation between the 10-year US Treasury yield and 10-year Singapore government bond yield has historically been high,” the OCBC report states.
On the other hand, the global economy is likely to recover from Covid this year and next. For instance, retail REITs and industrial and commercial REITs with SME tenants may no longer need to provide rental relief. CapitaLand Integrated Commercial Trust provided $128.4 million of rental waivers excluding government rebates compared to its distributable income of $369.4 million. Analysts point out that the absence of rental waivers and rental support alone could boost distributions per unit.
OCBC suggests investors could look at a “recovery basket” comprising retail and hospitality REITs given that we have already seen a more meaningful rotation to value and cyclical stocks globally. These could include Ascott Residence Trust, CapitaLand China Trust, Frasers Centrepoint Trust, Mapletree Commercial Trust and Mapletree North Asia Commercial Trust.
For investors with a longer-term horizon, OCBC suggests REITs which could be ‘beneficiaries of secular growth trends with room for solid inorganic growth opportunities’. In this bucket, it has Ascendas REIT, Frasers Logistics and Commercial Trust, Keppel DC REIT, Mapletree Industrial Trust and Mapletree Logistics Trust.
“Over the next 9–12 months horizon, we expect our recovery basket to outperform our resilient basket,” OCBC says
