Maybank Securities analyst Krishna Guha has upgraded the Singapore REIT (S-REIT) sector to “positive” after the US Federal Reserve (US Fed) indicated that it was going to cut rates soon.
On Aug 23, Fed chair Jerome Powell said that the “time has come” for the Fed to cut its key policy rate. Powell was speaking at the Kansas City Fed’s annual conference in Jackson Hole, Wyoming.
“The US Fed’s strong signalling of rate cuts should lower the discount rate for the REITs sector in Singapore and improve sentiment,” says Guha in an Aug 27 report.
Stating that this was a case of “classical conditioning”, the analyst notes that sentiment and flows will have been boosted by expectations of cuts, which will, in turn, lower the cost of capital and discount rates. Fair value estimates will also be improved in Guha’s dividend discount model (DDM).
Based on his calculations, every decrease of 50 basis points (bps) in the discount rate will improve fair values by 10% on average.
Furthermore, the lower cost of capital should help put a floor on asset values. This will also reignite the transaction market and drive capital recycling, he adds.
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The lower repricing of debt on floating rates will also soften growth of financing costs, says Guha.
Finally, should rate cuts lead to nominal growth, REITs may also see growth in their revenues.
That said, the analyst says borrowing costs will only decline if the rate cuts are deep enough and sustained. To this end, every 50 bps fall in base rates will lead to an average increase of 3.4% for distributions per unit (DPUs).
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Following the latest earnings season ended June 30, Guha notes that there were “no surprises” in the REITs results. DPUs and net asset values (NAVs) for the REITs under his coverage fell by 5.5% and 1% y-o-y on average. Despite resilient operations, the REITs’ DPUs and NAVs suffered from higher finance expenses, foreign exchange (forex) headwinds and an income vacuum from divestments and asset enhancement exercises.
Meanwhile, commercial and industrial REITs continued to show healthy positive rental reversions in their low-teens. CapitaLand Ascendas REIT A17U (CLAR), in particular, raised its reversion guide to high-single-digits.
At the same time, rental reversions for office REITs are likely to normalise as spot rent growth slows down. Retail reversions are also expected to trend in line with the growth of tenant sales.
Hospitality REITs’ revenues per available rooms (RevPARs) were impacted due to the traditionally low season and slower-than-expected growth in tourist arrivals. “Forward bookings are facing tough comps of last year,” says Guha.
Overall, the sector’s margins were also lower y-o-y but improved q-o-q from lower utility costs. At the same time, cost of debt rose slightly, while coverage ratios fell at a more gradual pace compared to the quarters before. The slight decrease in coverage ratios suggests a stabilisation of financial metrics, says Guha, who adds that Singapore asset values are “resilient”.
To this end, the analyst has widened his sector picks to include rate-sensitive REITs such as Lendlease Global Commercial REIT JYEU (LREIT), Mapletree Logistics Trust M44U (MLT) and OUE LJ3 REIT. These REITs were named for their sensitive to interest rates, forex and valuations.
Meanwhile, CapitaLand Integrated Commercial Trust C38U (CICT), CLAR and Frasers Centrepoint Trust J69U (FCT) remain Guha’s core picks due to their Singapore-centric revenue stream. They were also picked for their diversification in high-growth sectors as well as for their good hedging practices and strong credit metrics.
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“While valuations are tight, these attributes are comforting in a period of volatile transition from a high level of interest rates to a normalised level,” says the analyst.
Among the sector, he prefers the industrial and retail sub-sectors while he remains “neutral” on office and “cautious” on the hospitality sub-sector.
Guha has “buy” calls for CICT, CLAR and FCT with target prices of $2.25, $2.90 and $2.40 respectively. He also has “buy” calls for LREIT, MLT and OUE REIT with target prices of 65 cents, $1.50 and 30 cents respectively.
