RHB Bank Singapore analyst, Vijay Natarajan, has maintained his “overweight” call on Singapore REITs (S-REITs), following its year-to-date (ytd) retreat of around 4%, which slightly underperforms the Straits Times Index’s (STI) retreat of around 3%.
Natarajan understands this comes after a sharp rally during the last two months of 2023 from positive inflation data and an earlier-than-expected dovish US Federal Reserve (US Fed) pivot.
He writes: “We see the current pullback as temporary and an opportunity, as we expect S-REITs to outperform in 2024, with tailwinds from better economic growth and rate cuts. Sector news flows are expected to be incrementally positive, both operationally and on the balance sheet front, over the course of 2024.”
In his Jan 22 report, the analyst opines that the dominant theme and driver of S-REITs’ performance in 2024 will be the US Fed’s rate cuts and messaging surrounding the quantum and timing.
“RHB economists expect rate cuts to commence in the second half while expecting economic growth to be much stronger with a forecasted Singapore’s gross domestic product (GDP) growth of 3%, which is twice that of 2023’s,” notes Natarajan.
With this understanding of market conditions, the analyst expects “cyclical recovery plays” in office and hospitality, as key beneficiaries and to outperform.
He explains: “We continue to recommend investors to add on market corrections with a balanced mix of industrial REITs for stable yields, as well as a mix of office, hospitality, and retail REITs to ride on the recovery and rebound from the turn in the interest rate cycle.”
As such, Natarajan’s top picks are CapitaLand Ascendas REIT A17U (CLAR), Keppel REIT, AIMS APAC REIT (AA REIT), and CDL Hospitality Trusts J85 (CDLHT).
Balance sheet
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For the upcoming earnings season, the analyst expects it to be “muted and unexciting” from a distribution per unit (DPU) standpoint, as the majority of REITs are set to post y-o-y declines, dragged down by higher interest costs.
“Investors are likely to continue to place emphasis on the capital management front, such as gearing and hedging, as S-REITs navigate the tail-end of peak interest rates. Valuations outlook for overseas markets – Australia, the US, UK, and Europe – remains negative, with up to 10% declines expected from 50 to 150 basis points (bps) expansion in cap rates,” writes Natarajan.
On the other hand, Singapore asset values are expected to remain largely stable.
He continues: “However, we do believe we are at the peak of the asset devaluation cycle, with the possibility of upward revisions in 2024 for overseas assets.”
Shift to operational leverage expected in 2H.
With the Singapore economy set to gather pace this year, Natarajan expects investor emphasis to turn to operational resilience like occupancy and rent reversions, and its impact to bottom lines.
“S-REITs’ focus since 2H2022 has mainly been on divestments in order to lighten balance sheets and deploy some of this capital to extract value from existing portfolios via asset enhancements,” he adds.
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Although the analyst understands this trend to likely continue into 1Q2024, he also expects acquisitions and potentially new listings to make strong comebacks in 2H2024.
While S-REITs made around $3 billion in acquisitions last year, a 36% y-o-y decline, Natarajan expects a doubling of value to $5 billion to $8 billion this year.
Key catalysts for the sector include the remaining strong fund flows from institutional investors, rate cuts, and higher economic growth, while the economy’s tipping into a severe recession remains a key risk.
Office REITs
Natarajan has an “overweight” call on Singapore’s office sector, which remains a major outlier across global markets, with healthy overall central business district (CBD) occupancy levels of more than 95% and continued rent growth.
He expands: “This has been on the back of modest supply growth in the last three years, Singapore’s growing allure as a global financial hub in Asia, and a high return-to-office trend of around 80%.”
Furthermore, in 2024, a higher office supply in the CBD is expected with the completion of IOI Central Boulevard Towers, but, based on media sources, is only around 60% pre-committed, with Amazon and Morgan Stanley being the key tenants.
Nonetheless, the analyst believes the higher supply is likely to put some pressure on overall market occupancy, with vacancy levels expected to increase 2% to 3% during the course of the year.
“We expect Singapore CBD rents to be flattish at 0% to 2% for 2024, as the strong economic growth supports a healthy labour market and office demand. This should continue to result in low- to mid-single-digit positive rent reversion for office S-REITs,” writes Natarajan.
According to him, valuations for office REITs remain attractive at around 30% below book value, and thus presents an opportunity to add deeply-discounted Singapore office REIT stocks, such as Keppel REIT.
Industrial REITs
As the demand in the industrial sector is expected to remain resilient with non-oil domestic exports (NODX) to grow 3% this year vs 2023’s at 13.1%, Natarajan has an “overweight” call on the industrial sector.
He notes: “Broadly, most of the industrial S-REITs saw continued strengthening in operational metrics in 2023, with stable occupancy levels and healthy positive rental reversions. The logistics sector in Singapore and overseas markets, except China, continues to be the bright spot, with a healthy rental rate growth and continued demand for high-specification logistics facilities.”
Although inflationary pressures have weighed on operating costs, the REITs have mitigated this, partly by passing on some of the costs to tenants by increasing utility charges.
“Hence, net property income (NPI) margins are likely to be maintained around current levels moving forward. The industrial sector remains a defensive safe haven, and one that offers earnings stability and stable asset values amidst the ongoing interest rate hikes,” writes the analyst.
Among the sub-sectors, Natarajan likes logistics, hi-tech, and good-quality business parks, which continue to benefit from the shift in market dynamics brought about by supply chain shifts and the government’s longer-term push to transform Singapore into a smart nation.
His picks include CLAR, AA REIT, and ESR-LOGOS REIT J91U (E-LOG).
Hospitality REITs
Following the expectation of tourist arrivals to recover to 85% to 95% of pre-Covid-19 levels at 16 million to 18 million for 2024, the analyst has an “overweight” call on the hospitality sector.
Natarajan notes that the recovery in visitor arrivals is well-supported by a series of upcoming events, including the Singapore Air Show, and Coldplay and Taylor Swift concerts.
He adds that the recent move to lift visa restrictions for Chinese travellers is also expected to have a positive impact, considering that they were the largest visitor group before the pandemic, at around 19% of the 19.1 million visitor arrivals in total in 2019.
“For Nov 2023, Chinese visitors to Singapore slightly eased to 42% of pre-pandemic levels from 55% in July 2023. However, with the increase in flight capacities and China’s economy expected to recover in 2024, we expect Chinese visitors to rise to 60% to 75% of pre-pandemic levels, supporting overall visitors’ growth,” explains Natarajan.
Therefore, for hotel revenue per available room (RevPAR), Natrajan expects a “more modest” 2% to 4% y-o-y growth in 2024, mainly aided by occupancy improvements, with average room rate growth expected to be more flattish.
“The recent pullback in hospitality REITs’ share prices, in our view, represents a good tactical opportunity for investors to re-enter the sector. CDLHT is our pick for this segment,” concludes the analyst.
Overseas REITs
Since the 50% to 100% rebounding of US office REITs share prices during November to December last year, 2024 has seen a pullback.
Natarajan notes: “While we continue to believe US office REITs remain relatively undervalued, we do expect the recovery in the US office sector to be a long-drawn affair, with further bumps expected in 2024 before a potential stabilisation and recovery in 2025.”
Although structural headwinds are likely to persist in 2024, as the US office sector finds an “equilibrium” from return-to-office policies and hybrid working strategies, the analyst writes that overall, the sector is expected to gradually improve, with the worst “likely behind”.
As such, he has an “overweight” call on overseas REITs, pointing to the resilience of the economy and the implementation of stricter hybrid working policies as reasons behind his call.
“One of the key factors we are monitoring closely is the return of lenders’ appetites towards the commercial sector, which has been a key impediment in loan refinancing as well as investment market activity,” continues Natarajan.
Meanwhile, the overall economic outlook for European-focused REITs has thus far come in “slightly better” than anticipated, with inflationary pressures peaking.
In this regard, the analyst sees high-risk high-return opportunities in some of the good-quality US office and European-focused REITs, such as Keppel Pacific Oak US REIT (KORE) and Cromwell European REIT (CREIT).
Retail REITs
Unlike his call on the other sectors, Natarajan has a “neutral” call on retail REITs.
He explains: “Retail REITs posted a strong set of operational numbers for the latest quarter ended Sep 2023. Tenant sales growth, though, are starting to taper off and normalise, which we attribute to slight easing in economic growth and cutbacks on the back of inflationary pressures. This, however, has been partially offset by a rising number of tourist arrivals.”
In 2024, key challenges for the sector remain a further raise in goods and services tax (GST) charges and the impact of inflationary pressures on tenants, although this is likely to be offset by higher tourist spending and economic growth in the second half.
“Overall, we expect the focus for retail landlords to remain on maintaining high occupancy rates, curating their mall tenant mix, and attracting high-quality tenants while being slightly flexible in terms of rental rates,” notes the analyst.
Natarajan expects to see a slight positive growth of 1% to 5% in retail sector rents, which translates into healthy positive rental reversions for retail S-REITs in the “mid-to-high” single digits.
He concludes: “CapitaLand International Commercial Trust remains the best proxy to retail-cum-office exposure to Singapore. In the mid-cap space, Starhill Global REIT P40U is still the best proxy to capture higher tourist spending-led growth, with the bulk of its portfolio located along Singapore’s Orchard Road.”
