The yield on 10-year Singapore Government Securities (SGS), the so-called risk free rate, has retreated somewhat from its peak of 3.18% since mid-June.
The local risk-free rate is important to REIT investors because unit prices of REITs are affected by the 10-year SGS yield through the yield spread. In fact — and this is despite S-REITs looking increasingly overseas for assets — when listed and traded on the Singapore Exchange (SGX), S-REITs are inevitably impacted by local risk free rates as well as the risk-free rates of the geographies where their properties are located.
The retreat by these 10-year yields means that the downward pressure on S-REITs caused by the yield spread has been alleviated. At its peak, the yield spread, based on The Edge Singapore’s big REIT table, stood at 316 basis points (bps) compared to 395 bps to 400 bps in January, when the risk free rate was at around 1.8%, and the average yield of the 40 or so REITs was around 5.8%. The yield spread of 400 bps is similar to the 10-year mean indicated by SGX Research.
As at July 6, when Singapore’s riskfree rate declined to 2.8%, the yield spread stood at 350 bps. S-REIT pricing may continue to adjust if the risk free rate continues to decline.
The cost of debt of REITs is a separate issue affecting distributions per unit (DPU), and this may continue on an upward trend, impacting REITs with higher floating rates to a greater extent than those with high fixed rate debt.
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The Edge Singapore’s big REIT table indicates the portion of fixed debt each S-REIT has, as at the latest half year announcements. Suntec REIT’s fixed rate debt is 51% of total debt of $4.95 billion, while the fixed rate debt of Lippo Mall Indonesia Retail Trust and CDL Hospitality Trusts stood at 54%. Keppel REIT’s fixed rate debt has risen dramatically, to 71% from 63%, fortifying its balance sheet.
Based on the minutes of the US Federal Reserve (Fed) latest Federal Open Market Committee (FOMC) released on July 6, a 75 bps rate hike is likely this month, taking the US Federal Funds Rate (FFR) from 1.5% to 1.75% to 2.25% to 2.5%.
Since Singapore does not have an independent interest rate policy but an exchange rate policy where the Singapore dollar is measured against a basket of currencies, our policy rates which are now based on the Singapore Overnight Rate Average (SORA) are highly correlated to US rates. As a result, SORA should continue to rise despite an already steep surge since June this year. Lenders usually charge a margin above SORA. The rise in SORA and the FFR implies that cost of debt is likely to remain elevated.
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While the retreat in risk-free rates is good for unit price of REITs in the short-term, the likelihood of an inverted yield curve is also higher as evidenced by the rise in short-term treasury yields in the US. If this trend persists, a recession could materialise. Should the latter happen, equities may suffer, which is why the chart of the Straits Times Index continues to display its double top-like chart pattern. Many factors go into the valuations of equities and REITs, including business outlook, cash flow and market sentiment. But interest rates affect asset valuation, and they probably have an outsized bearing on the stock market.
