The Straits Times Index has had a particularly turbulent week. Interestingly, the turbulence was not caused by the US Federal Reserve’s fourth hike this year, of 75 basis points (bps) on Sept 21–22. Instead, it was caused by the British Chancellor of the Exchequer’s mini Budget. Sterling fell as did 10-year gilts, while yields on the 10-year gilts surged to as high as 4.5% before retreating.
Why would gilts impact the local market? Singapore corporates were encouraged to go overseas, and the UK was an attractive destination for some. The sudden surge in yields of 10- year gilts to 4.5% (before easing), and the decline in 10-year gilts from GBP120 ($186.69) in July to GBP100 in Sept led to something of a selloff in companies with exposure to the UK.
City Developments (CDL) fell to a low of $7.64 on Sept 28, before rebounding to $7.67 but ending at $7.61 on Sept 29. Prices are still up 11% since the start of the year, though. Still, the decline on Sept 28 caused prices to break below the 200-day moving average at $7.74. For much of this year, CDL’s 200-day moving average had been rising gradually, despite the sometimes volatile price movements. The break below the 200-day moving average took place as prices broke below a one-year uptrend.
CDL rebounded following the Bank of England’s decision to buy GBP65 billion of government bonds to calm the financial markets after it became evident that some types of pension funds were at risk of collapse, according to the BBC. The break below the 200-day moving average on volume expansion is more likely to be a sign of selling for CDL shares. Meanwhile, the rebound on Sept 29 took place on light volume.
Why was CDL impacted? According to a recent DBS Group Research report, some 11% of CDL’s assets are in the UK. Indeed, from 2014 to 2016, CDL invested around $1 billion in the UK. One of the many assets is Stag Brewery, acquired in 2015, for GBP158 million. Earlier this year, CDL attempted to list a commercial REIT with UK assets, namely 125 Old Broad Street and Aldgate House. In 2018, CDL acquired 125 Old Broad Street with a net lettable area of 328,819 sq ft for GBP385 million and Aldgate House with an NLA of 210,504 sq ft for GBP183 million.
In 2016, CDL bought Development House in Shoreditch, a six-storey office building with an NLA of 28,266 sq ft for GBP37.4 million. In 2017 CDL acquired Ransomes Wharf in London for GBP58 million. More recently, in 2019, CDL decided to expand into the private rented sector (PRS) with some bite-sized acquisitions in Leeds and Birmingham.
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Perhaps more puzzling is CDL’s outlook for its UK franchise which sounded upbeat despite the onset of a rising rate cycle. “The year 2021 saw the strongest year in real estate price increase in the UK since the Global Financial Crisis. The strong housing demand was driven by the pandemic-fuelled desire for more space as well as the stamp duty holiday, which resulted in high sales activity. Rental growth and demand remain strong. As more buyers return to the capital, the group expects the sales for its two prime London developments in Belgravia and Chelsea to pick up in 2022,” CDL said in its FY2021 ended Dec 31 annual report that was issued in March this year.
Marketing activities are ongoing for Teddington Riverside, CDL’s 239-unit development in Southwest London, with more than 43% of the units currently occupied. CDL says it is on track to submit its revised planning application based on a hybrid scheme for the former Stag Brewery site in Mortlake in 1H2022, even as it progresses with plans for its other three development projects in London — namely Ransomes Wharf, Development House and 28 Pavilion Road. But with UK mortgage rates in flux, it remains to be seen if there are any buyers.
CDL Hospitality Trusts (CDLHT) fell from $1.29 as at Sept 22 to $1.11 as at Sept 28 before rebounding. CDLHT is a lot more impacted than CDL which still has limited income from the UK. For CDLHT, 15% of net property income (NPI) in 2QFY2022 ended June 30 is from the UK. In addition, although 63% of CDLHT’s debt is on fixed rates, this is because 100% of its yen debt is on fixed rates. For CDLHT’s SGD debt, 55.1% is floating while 46.8% of GBP debt is floating. Furthermore, $92.1 million of a GBP fixed term loan expires in December this year, and $39.4 million of a GBP fixed bridge loan expires in February 2023. Some analysts have flagged CDLHT as one of the companies likely to be adversely affected by rising policy rates.
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Over and above the impact of higher interest expense on income, REITs take their unit pricing off risk-free rates. Traditionally, S-REITs trade at a level 390bps higher than the 10- year Singapore Government Securities (SGS) yield. Hence with yields on 10-year SGS at 3.4% or so, S-REITs should be trading at an average of 7% unless their DPU growth can get the DPU yields higher.
As at Sept 29, markets are still skittish, global risk-free rates continue to rise and the GBP remains weak. Calm may only return if the US Federal Reserve’s dot plot flattens and turns down, and the Fed articulates a neutral or less aggressive rate hike policy. And that can only materialise when inflation subsides.
