DBS Group Research analysts Dale Lai and Derek Tan believe that industrial Singapore REITs (S-REITs) with Australia, the UK and European exposure are unjustifiably sold off.
In their Oct 12 report, the analysts point out that REITs with assets in the three markets have generally reported some valuation declines over the past 18 months due mainly to cap rate expansions.
Assets in the UK were among the first to experience cap rate expansion but have since stabilised, while assets in Europe and Australia have seen cap rate expansion pick up in FY2023, the analysts note.
Despite the expansion in cap rates, the drag on valuations has partially been offset by the very strong positive rental reversion and improvement in property occupancy rates especially for logistics properties, say Lai and Tan.
“As interest rates stay high, the risk of net asset value (NAV) erosion remains for selected S-REITs with assets in these markets, but the fundamentals remain supportive, which could mean that the downside risk is less than expected.
“Nevertheless, we believe that investors have priced in a ‘doomsday’ scenario and we believe that while asset valuations are likely to see some pressure, the impact will be far lesser than what the market has priced in,” the analysts add.
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To this end, the analysts think Frasers Logistics & Commercial Trust BUOU (FLCT) and Keppel DC REIT AJBU are the most attractive among the five S-REITs with significant exposure to Australia, the UK and Europe. They note that FLCT and Keppel DC REIT’s asset values have held up well despite pressure of cap rate expansion due to the nature of their portfolios of largely logistics assets and data centres respectively.
Lai and Tan believes that FLCT will report some revaluation losses in FY2023 as it is the period when the speed of cap rate expansions picked up. While they think FLCT’s portfolio average cap rate could see a 50 basis points expansion, the continued growth of rentals for logistics and industrial properties during the period will help to partially offset some of the impact to portfolio valuations and NAV.
Similarly, rental growth and improved occupancies of data centres will also enable Keppel DC REIT’s valuations to remain relatively stable, even if cap rates slightly expand. The analysts note that a majority of the REIT’s portfolio exposure is in Singapore, where cap rates are expected to be maintained and will likely see some revaluation lift.
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For European exposure, Cromwell European REIT (CEREIT) CWBU stands out for its proactive deleveraging strategy coupled with resilient yields. The analysts highlight that CEREIT is ahead of its peers in terms of maintaining its property values, while its ongoing redevelopment projects act as another layer of defence against potential valuation declines over the near to medium term.
“Even if interest rates are markedly higher in the coming year, we estimate that FLCT, Keppel DC REIT and CEREIT would still be able to maintain interest coverage ratios in excess of 3x in an unlikely scenario of a 30% drop in ebitda.
“This buffer, coupled with our estimates that average gearing ratios should not breach 45%, provide us with further comfort that at least these three REITs are ‘value buys’ in the current part of the cycle and have the financial strength to deliver resilient returns in the face of economic uncertainty and stress,” the analysts add.
As at 1.58pm, units in FLCT, Keppel DC REIT and CEREIT are trading at $1.06, $1.92 and EUR1.28 respectively.
