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Despite narrowed yield spreads, S-REITs offers one of the 'highest' spreads among global markets: RHB

Bryan Wu
Bryan Wu7/21/2022 12:44 PM GMT+08  • 5 min read
Despite narrowed yield spreads, S-REITs offers one of the 'highest' spreads among global markets: RHB
Natarajan anticipates investors shifting back to industrial REITs in 2HFY2022 as defensive REIT plays, with income resilience a priority amid a more challenging and uncertain global economic outlook. Photo: Albert Chua/The Edge Singapore
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RHB Group Research analyst Vijay Natarajan has maintained his “overweight” rating of the Singapore REIT (S-REIT) sector, which he says is growing despite rising risks.

Reminding investors to “stay selective” amid a challenging outlook, Natarajan says: “Despite rising macroeconomic risks and inflationary pressures, we expect S-REITs to register positive DPU growth in 2022. While volatility is expected to increase, we believe selective REITs are currently trading at attractive valuation, offering good long-term entry levels.”

In his report dated July 21, the analyst anticipates investors shifting back to industrial REITs in 2HFY2022 as defensive REIT plays, with income resilience a priority amid a more challenging and uncertain global economic outlook. Defensive REIT plays take precedence over reopening play sectors REITs such as hospitality and retail, which outperformed in 1HFY2022, he says.

Industrial REITs remain RHB’s “preferred” choice as the “most resilient” sector, followed by office REITs, adds the analyst, whose top picks are Ascendas REIT (A-REIT), Suntec REIT, ESR LOGOS REIT (E-LOG) and AIMS APAC REIT (AA REIT), with target prices of $3.60, $1.95, $0.53 and $1.66 respectively.

Natarajan expects distribution per unit (DPU) growth for his stock picks of 6% and 3% for 2022 to 2023 on the back of Singapore’s economic reopening as their valuations are “looking attractive”, with nearly two-thirds of the REITs trading below book value and offering yields of over 6%.

Singapore’s growing status as Asian financial hub with a good number of sovereign and pension funds as well as family offices of high net worth individuals (HNWI) setting up regional offices, while office REITs in general are seeing continued rent growth amid a slow, but steady, return to office trend, he notes.

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According to Natarajan, there will be a varying but manageable impact from rising utility charges and interest rates. He says: “Based on our discussion with various REIT managers, rising utility

On the balance sheet front, around 75% of total S-REITs debt is hedged with a potential DPU impact of 0% to 5% for every 50 basis points (bps) hike in interest rates. SREITs floating rates are typically pegged to the three-month compounded Singapore Overnight Rate Average (SORA) which typically lags behind the US Federal Reserve (US Fed) rate hikes and does not rise in an equal proportion. Year to date (ytd), SORA is up 57 bps compared to the 150 bps benchmark rate hike by the US Fed, notes the analyst.

Despite this spike in interest rates, Natarajan believes asset values will remain relatively firm, given that increased competition, real estate utility as a hedge against inflation and better clarity on post Covid-19 outlook have resulted in strong demand and continued cap rate compression for commercial and industrial assets. He writes: “We do not expect cap rate expansion, especially for Singapore focused assets.”

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Conversely, the outlook for cap rates in key overseas markets, such as Australia, the US, the UK and Europe, are less favourable in RHB’s view, with a possible cap rate expansion of up to 50bps by end of the year, says Natarajan. The acquisition pace in these markets has nearly halved to $3.5 billion in 1HFY2022, and is expected to slow down further with overall acquisition value of $5 billion to $8 billion for 2022.

While yield spreads have narrowed, S-REITs still offer one of the highest spreads globally, claims Natarajan. The sharp spike in treasury and bond yields have resulted in the spread between the Singapore 10-year treasury and S-REITs’ average yield to narrow to 262 bps as of end-June compared to 380 bps at the start of the year.

This compression has been mainly due to the sharp increase in 10-year treasury yield while S-REITs DPU outlook has remained largely stable to slight improvement despite rising inflationary pressures, says the analyst, adding: “It also has to be noted that S-REITs still offer among the highest yield spread among key global REIT markets.”

One area of concern, however, has been the impact of China’s policy tightening measures on the refinancing of debt due for China focused S-REITs. The stringent policy measures targeting the real estate sector has resulted so far in two S-REITs facing issues upon refinancing, Dasin Retail Trust and EC World REIT, with both managing to roll over their debt only for a shorter time period, points out Natarajan.

In addition, banks have imposed additional conditions to reduce overall debt but this is unlikely to impact China focused S-REITs with a strong sponsor backing like CapitaLand China Trust (CLCT) in our view, he says.

Natarajan adds the caveat that as RHB’s base case assumption remains that there will be no recession in 2022 to 2023 for Singapore, a key risk remains that the economy tips into a deep recession with persistent inflationary pressures.

“While we believe S-REITs have largely priced in the impending rate hikes, assuming [there is] no 100 bps hike, we see more downside for the sector if economic growth starts weaning off sharply,” he says.

As at 12.26pm, shares in A-REIT, Suntec REIT, E-LOG and AA REIT are trading at $2.87, $1.58, 40 cents and $1.37 respectively.

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