DBS Group Research analysts have maintained their strategic call to shift allocations into retail, commercial, and hospitality Singapore REITs (S-REITs), as the overall rate environment gradually normalises.
These sectors are trading close to the -1 standard deviation (s.d.) of the mean in P/BV and yield terms, say the analysts.
Sticky inflation numbers observed in the US during January and February of 2024 have prompted investors to re-evaluate their expectations of the US Fed delaying rate cuts till the second half of 2024. DBS economists maintain their stance of four rate hikes starting June 2024, even as markets harbour suspicion of a later move.
“That said, we find the overall valuations of S-REITs appealing, trading at an average 0.78x p/b (-1 s.d.) and FY2024 yield of 7.0%. These valuations translate to a yield spread of about 4.0%, a level that has historically attracted significant allocations back to the sector,” the analysts say.
They note that S-REITs have corrected by close to about 9.1%, with total returns of -5.6%, since the beginning of the year.
Meanwhile, the pace of interest rate increases is decelerating. Even though the average dividend per unit (DPU) was generally lower y-o-y in FY2023, except for hospitality S-REITs (+19% y-o-y), ebitda growth was generally positive at about 4% y-o-y, the analysts note.
They expect ebitda to remain on a steady uptrend in FY2024 fuelled by rising rents in the Singapore property market, which is currently in a favourable phase of the property cycle for landlords.
“While interest costs are still rising, 4QFY2023 recorded the smallest quarterly increase (0.1% q-o-q, 0.7% y-o-y), indicating that average portfolio interest costs are aligning with current market conditions. The normalisation trend expected in 2HFY2024/2025 could provide an additional boost to DPU growth, which we have yet to factor into our projections,” say the analysts.
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In addition, the analysts find that most S-REITs have stayed within their defined limits, with financially resilient metrics.
Although average interest coverage ratios (ICR) and aggregate leverage (gearing) ratios have weakened since the end of FY2022, the ratios for most S-REITs have stayed within the regulatory limits of more than 2.5 times and about 39% respectively.
“This further underscores our view that overall financial and liquidity conditions remain conducive for most, except for the US Office S-REITs which had cut or suspended dividends to preserve capital. We do not see this happening for other sub-sectors,” they add.
That said, looking ahead, most S-REIT managers are sounding an air of caution for 2024, although most still see positive but single-digit rental reversionary trends during the year, the analysts note.
Most hoteliers still paint a fairly rosy outlook for the first half of 2024, especially in Singapore, on the back of a robust event and concert line-up. Industrial, retail and office landlords are calling for more caution in 2024, dialling down expectations on the back of a cautious operating outlook, with stubborn inflation rates impacting business operations costs and margins.
The analysts say that as the world approaches a period of nearing interest rate cuts, it creates a favourable environment for interest-rate sensitive instruments like REITs. Although they see volatility in the interim, they believe investors should continue to add to their positions.
“Our sector preference of retail, followed by offices, then hotels and industrials is unchanged at this juncture,” they say.
