RHB Bank Singapore analyst Vijay Natarajan has maintained his “overweight” call on the Singapore REITs (S-REITS) sector, as an earlier-than-expected interest rate cut and resilient economic growth have presented as key catalysts for the analysts’ optimism towards the industry.
S-REITs have fallen about 27% in absolute terms since the interest rate hikes started in 2022, caused by a surge in ultra-low financing costs enjoyed over the past decade.
This has resulted in lower distributions, coupled with asset value decline from cap rate expansions (especially overseas markets) as investors demanded higher acquisition yields to offset the rising cost of capital, says the analyst.
As a result, the high interest rates made a host of other higher-yielding options available in the market — high-quality corporate bonds, treasury bills, and fixed deposits narrowing yield differential, resulting in a significant capital shift.
Notably, the analyst says that as the world approaches the tail-end of the current interest rate upcycle, there is a reversal of the aforementioned factors driving capital flows back to the sector.
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“RHB Economics expects one rate cut by the US Federal Reserve in 4Q2024 with more on the cards next year. While interest rates are unlikely to go back to pre-pandemic levels, a normalisation of rates by 100 - 200 basis points (bps) lower in the medium term could provide [a] 30% - 50% upside to the sector,” says Natarajan.
Additionally, gross domestic product (GDP) growth is expected to be more than double that of last year, which should aid in continued better operational performance and top-line growth, with a peak in interest cost pressures anticipated by end of the year, he adds.
“Currently, S-REITs offer an average yield of about 7%, with a yield spread of about 360 bps over 10-year government bond yields — higher versus global major REIT markets ie the US, UK, Japan, and Australia,” says the analyst.
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He adds that in P/BV terms at 0.85 times, the valuation of the sector looks much more attractive and is well below the long-term mean (since 2010) of 1.03 times.
He explains that this is due to the relatively stable cap rates across Singapore assets over the last two years, as well as investor expectations of further declines in valuation.
“However, based on transactional evidence and discussions with valuers, the demand for Singapore assets continues to remain strong while cap rates are expected to remain largely stable,” says Natarajan.
The analyst prefers large-cap industrial and office REITs with modest gearing and strong sponsor backing as the market awaits greater clarity on interest rates.
“Industrial S-REITs still have the most defensive characteristics with favourable demand-supply dynamics and stable cash flow while office S-REITs remain the most attractive in terms of valuation amid undue investor concerns over the sector. In the near term, hospitality S-REITs too offer good upside potential from continued strong tourism recovery in Singapore,” he ends.
