Given the high percentage of loans on fixed rates, it will take time for S-REITs to benefit from interest rate cuts. However, Phillip Securities analysts expect fewer rate cuts from the US Federal Reserve in 2025, down to three from five previously.
The Fed cut its benchmark rate by 25 basis points (bps) to a target range of 4.5%-4.75% on Nov 7, the second consecutive rate cut this year after September’s 50bps cut.
“With Trump elected as president, the trajectory of future rate cuts has become more uncertain due to the potential inflationary impact of his policies,” say analysts Darren Chan and Liu Miaomiao in a Nov 25 note.
Most REITs have already repriced their debt to the current level of interest rates, and the analysts expect interest costs to start trending down in 2025. “We expect a turnaround in 2025 as S-REITs begin to benefit from lower rates with the gradual expiration of interest rate hedges.”
S-REITs slumped 5.5% in October, reversing the 3.5% gain in September. The top performer for the month was Keppel DC REIT, gaining 5.5% after it reported above 40% positive rent reversion for its major Singapore contract renewal. Acrophyte Hospitality Trust was the worst performer, falling 14%.
Chan and Liu remain “overweight” on S-REITs, preferring the usual suspects with “healthy balance sheet, strong sponsors, improving operating metrics, and lower interest rate hedging ratios”.
See also: OCBC, citing potential recovery, initiates coverage on Nanofilm with tentative 'hold' call
Retail focus
In particular, the analysts prefer the retail sub-sector, as rental reversions remain strong. “The return of international visitor arrivals could boost tenant sales and sentiment. Retail tenants are willing to pay higher rents due to the still below-average occupancy cost. We expect high single-digit positive rent reversion for suburban malls and double-digit positive rent reversion for downtown malls, supported by the limited supply of new retail space.”
Rental reversions continue to be strong in 3Q2024, say the analysts. Frasers Centrepoint Trust J69U and CapitaLand Integrated Commercial Trust C38U had positive suburban mall rental reversions of 7.7% and 9.0% respectively.
See also: Macquarie revises Singapore earnings growth for FY2024 to 7% from 3%
Downtown malls reported even higher rental reversions, with Suntec REIT’s Suntec City Mall and OUE REIT TS0U ’s Mandarin Gallery achieving positive rental reversions of 21.2% and 16% respectively.
Despite tenant sales slowing across all REITs, with some even reporting y-o-y declines, landlords noted that tenants are still willing to pay higher rents that are supported by the low occupancy cost.
“The demand from overseas retailers, new F&B concepts, and the shift to entertainment and wellness will support rental growth,” say Chan and Liu. “We expect a positive rent reversion of high-single-digit to low-teens in FY2025, supported by the limited supply of new retail space.”
Phillip Securities’ top picks are Cromwell European REIT, OUE REIT and CapitaLand Ascott Trust HMN (CLAS). With “buy” calls on all three, the analysts have target prices of EUR1.95 ($2.74) for Cromwell European REIT, 40 cents for OUE REIT and $1.04 for CLAS.
Widening yield spread
S-REITs are now trading a forward dividend yield of 6.1%, 0.1 standard deviations above the mean, and a price to net asset value (P/NAV) of 0.9 times, 1.4 standard deviations below the mean of 1.03 times after the S-REITs Index fell 5% in October.
For more stories about where money flows, click here for Capital Section
Interest rates have peaked as most REITs have already repriced their loans, say the analysts. “Therefore, we think this is a good time for investors to reposition into S-REITs to capture future growth in distribution per unit (DPU) from lower interest expenses. The dividend yield spread has risen from 3.1% to 3.3% m-o-m and is now 1.1 times standard deviations below the mean of 4%.”
With more rate cuts on the horizon, Chan and Liu expect the distribution yield spread to widen as the Singapore 10 Year Government Bond yield declines, making S-REITs an “increasingly attractive investment proposition”.
Table and charts: Phillip Securities
