SINGAPORE (Mar 27): Rising interest rates does not necessarily spell doom and gloom for Singapore REITs (S-REITs) if the hikes were made in response to improving economic conditions, says Phillip Capital in a Monday report.

As widely expected, the US Federal Reserve last week raised rates by 25 basis points to 1.75%, while maintaining its forecast for three rate hikes total for 2018.

But even as the Fed upgraded its outlook for the economy, it expects near term inflation in 2018 to remain benign, with both core and headline inflation projection coming in at 1.9%.

According to Phillip analyst Tan Dehong, news of the hike was largely shrugged off in terms of its impact on REITs with the FTSE S-REIT Index down a marginal 0.2% the day after the rate hike.

Nonetheless, Tan says the S-REIT sector looks to be pricing in some of these headwinds from the macro front this year, with the FTSREI down 5.4% year-to-date vs the STI’s +0.1%.

Based on the Fed’s latest assessment, it should continue to be an accommodative environment for S-REITs with strengthening economic growth and tepid inflation which allows the Fed to maintain a gradual pace of rate hikes.

On average, Tan notes that about 80% of S-REITs across the various sectors have at least 70% of their debt hedged on fixed rates in anticipation of higher interest costs. This helps mitigate the impact of rising interest rates on 2018 DPU.

For the REITs under Phillip's coverage, Tan estimates DPU will be negatively impacted 1-3% by a 100bps increase in financing costs from current, assuming current interest rate hedging status. Assuming a zero hedging scenario, DPU could be negatively impacted 8-12%.

At 5.3%, S-REITs currently offer one of the highest absolute yields among major REIT markets of the US, HK, Japan and Australia. However, current yield spread of 2.9% is at a -1 s.d. level from post-Global Financial Crisis average, reflecting valuations are on the more expensive side, says Phillip Capital.

Meanwhile, apart from retail, all other sectors -- office, industrial and hotels -- generally face a positive scenario of tapering supply after a peak in supply in 2017.

"The easing of supply in 2018 should build a base for rentals to start climbing up," says Tan adding this should mitigate the magnitude of negative rental reversions we are expecting for the retail, industrial, and office sectors.

Apart from interest rate hikes, regulatory changes announced during Singapore’s Budget 2018 could also affect S-REITs, Singapore-listed REIT exchange traded funds (ETFs) will no longer be subjected to the 17% corporate tax on the specified income distributed to the unitholders.

Expected to be enacted on or before July 1, this change will even the parity of tax treatments between individual S-REIT counters and S-REIT ETFs.

Demand will inevitably flow down to the three Singapore-listed ETFs and correspondingly, the S-REIT portion of the entire Singapore-listed REIT ETF pie.

Total market capitalisation of all three REIT ETFs currently stands at $264.71 million, in comparison to the $80.9 billion market capitalisation of the entire S-REIT market.

Phillip has "accumulate" on Ascendas REIT, Cache Logistics Trust and Dasin Retail Trust with a target prices of $2.89, 93 cents and 98 with forecast dividend yields of 5.5%, 6.5% and 10.2% respectively.

Units in A-REIT, CacheLog and Dasin are trading at $2.61, 84 cents and 87 cents respectively.