Some analysts remain sanguine about the impact of rising risk-free rates which are yields 10-year government bonds, on REITs’ unit prices.
UOB Kay Hian has said S-REITs provide an attractive distribution yield of 5.90%, which is 0.9SD above long-term mean. The downside is limited to a correction of 10.1% if yields spike to 2SD above mean at 6.56%.
CLSA appears more realistic. For REITs, higher refinancing cost result in DPU erosion for companies with a low hedges for fixed rates and high gearing. “Ascott Residence Trust, Keppel REIT and Suntec REIT are the most vulnerable in this aspect with potential 3.7%-7.8% DPU erosion for every 100bp rate rise,” CLSA says.
Furthermore, rising rates over an extended period will result in higher cap rates for assets, lower book values and higher gearing. “We believe Suntec REIT, Manulife US REIT and Keppel REIT to be the most susceptible to rising cap rates,” CLSA indicates.
In the meantime, the growth proposition will be derailed for now. The higher cost of capital environment will rein in acquisitions for S-REITs and result in slower DPU growth, the CLSA report adds.
For property developers, higher mortgage rates will eventually impact housing affordability, CLSA indicates. Recent launches have seen healthy take-ups, but secondary volume has started to ease. That said, several rounds of property cooling measures have kept household gearing in check and should avoid a hard landing in the residential segment, it adds.
Interestingly, UOB Kay Hian is expecting the higher interest rate environment to persist. “We expect the Fed Funds Rate to hit 4.25% by end-2022 and 4.50% by end-2023,” UOB Kay Hian says in a note dated Sept 27. Yield for Singapore 10-year government bond has increased 35bp to 3.33% in 3Q2022, the report adds. That surely will impact REITs’ unit prices if the yield spread of 390bps – 400 bps is to be maintained. It’s more likely that to maintain the yield spread, yields are likely to expand to 7%-8% unless DPU rises significantly. UOB Kay Hian has cut its target prices for S-REITs by an average of 7%.
Strategists at Nomura lowered their target for the GBP to US$0.975 by year-end, anticipating it will breach parity by the end of November. Morgan Stanley strategists also revised their GBP calls, with a year-end target of US$1. Tighter monetary policy which raises concerns about growth and fiscal sustainability, either directly or indirectly, is unlikely to see GBP strength in response.
DBS Group Research points out that the overall exposure to UK by S-REITs is at 3%. However, CDL Hospitality Trusts and Frasers Hospitality Trust – which failed to privatise at an offer price of 70 cents and is now trading at 50 cents – have a lot more than a 3% exposure. For CDLHT, 15% of net property income (NPI) in 2QFY2022 is from UK. Some 17% of FHT’s NPI was from UK in 1HFY2022.
According to Suntec REIT’s 1HFY2022 (six months to end-June) results presentation, 12% of its income is from UK. In July, Suntec REIT acquired the Minster Building for the equivalent of $667.2 million when the GBP was $1.89.
Elite Commercial REIT’s assets, revenues and debt are all in British pounds so there no forex exposure for the REIT as it was listed as sterling play.
“Amongst developers, Ho Bee Land stands out for its pivot to UK through strategic acquisitions in UK over the past few years, with The Scalpel being the latest addition,” DBS indicates. “While currency headwinds is noted, we take comfort that most S-REITs tend to (i) naturally hedge their foreign currencies (liability = asset) reducing NAV exposure, (ii) take on forward hedges (6 mth – 12mth) for foreign currency exposures. Our sensitivity analysis indicates a 10% drop in the GBP to SGD exchange rate will result in a 0.1% to 1.6% dip in distributions.”
The volatility in the UK may also mean that CDLHT’s sponsor, City Developments, is unlikely to get its UK commercial REIT to list this year unless there is a drastic change in economic conditions.