RHB Group Research analyst Vijay Natarajan has maintained his “overweight” call on the Singapore (REITs) S-REITs sector, despite calling 2022 “a year of opportunities and risks.”

In a Jan 19 report, Natarajan notes that S-REITs delivered a modest 6% in total returns in 2021, albeit impacted by lingering Covid-19-related restrictions.

In 2022, S-REITs are well positioned to weather interest rate hikes and should also reap operational benefits from the gradual easing of pandemic-related restrictions.

“We recommend investors stay selective, and expect large-cap laggard plays and REITs with stock-specific catalysts to outperform,” he thinks.

Some catalysts for the sector, Natarajan thinks, are earnings recovery from easing of restrictions with sector DPUs expected to grow by 5-15% in 2022, as well as inorganic growth from acquisitions and mergers.

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Furthermore, S-REITs still offer one of the highest yields globally, and the rise in Singapore’s status as an offshore wealth management hub is positive for the sector’s long-term outlook.

On the other hand, a key risk for the sector is stagflation and interest rate hikes.

However, he says that a rising rate environment as such is not necessarily bad for the sector’s outlook, if it is accompanied by economic growth. This is because earnings growth generally tend to outpace rate hikes.

Natarajan points at the last US interest rate upcycle from Jan 2016 to Aug 2019, where FTSE Real Estate Investment Trust index delivered an absolute return of 31%, or an annualised 9% return.

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However, he cautions that a scenario in which S-REITs are likely to underperform is when central banks are forced to raise interest rates to tame surges in inflation, while economic growth stagnates.

As for the Covid-19 pandemic, the analyst says that “we believe we are at the tail-end of its risks, as high vaccination rates, shifts in stances towards treating Covid-19 as endemic, and increased adaptability from landlords and tenants place the sector in a better position.”

Nevertheless, Natarajan thinks that S-REITs are better prepared to ride an interest rate upcycle, saying from a balance sheet standpoint, S-REITs are well poised to weather the rate hikes, with sector gearing at 37%, well below the regulatory limit of 50%.

In addition, nearly 77% of S-REITs debts are hedged, with sector average interest cover of 5.2x and weighted average debt maturity of 2.8 years.

For him, he prefers industrial and office REITs, saying that while office and retail REITs are likely to see short-term outperformances on tactical rotations from the optimism of an economic recovery, he prefers industrial REITs for earnings resilience.

While there are some “green shoots” for hospitality REITs, he thinks the sector is still at least 6-12 months away from a meaningful increase in numbers, adding that current valuations are also not very cheap.

Overall, he recommends investors adopt a barbell strategy with industrial REITs for stable yields, as well as a mix of office and retail REITs to ride on near-term growth.

His top picks are Ascendas REIT, Suntec REIT, ESR REIT and Prime US REIT, with “buy” calls and target prices of $3.60, $1.72, 54 cents and US$1.04.

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