The OCBC Investment Research (OIR) team believes that the Singapore REIT (S-REIT) sector is at a “long-awaited turning point”. The sector, which has been “bludgeoned” by the Covid-19 pandemic, sticky inflation and elevated interest rates, has been underperforming the benchmark Straits Times Index (STI) and the MSCI Singapore Index since 2020 to date.
“Notwithstanding limited historical data for S-REITs, the sector’s share price performance is dependent, in our view, on the driver and rationale behind rate cuts by the Federal Reserve (Fed),” the team writes in its Aug 23 report. “Easing inflation trends and a softening US labour market are setting the stage for the Fed to start cutting rates by 25 basis points (bps) each in September and December.”
On the evening of Aug 23, Fed chair Jerome Powell said that the “time has come” for the Federal Reserve to “adjust” its policies. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook and the balance of risks,” he added in his speech at Jackson Hole, Wyoming, where the Kansas City Fed’s annual conference was held.
The way the OCBC team sees it, the lowered financing costs from interest rate cuts could support a gradual recovery in the growth of distributions per unit (DPUs).
Furthermore, with the global economy now “broadly resilient” and seems to be poised for a soft landing, S-REITs seem “positioned to outperform”.
“We are also seeing nascent signs of improvement in liquidity in capital markets and funding environment, which could provide an uplift to investors’ sentiment,” the team writes.
See also: UOBKH calls Centurion Corp a stock for ‘growth-minded investors’
That said, it may be difficult to time the bottom of the market due to risk factors such as the upcoming US presidential elections and ongoing geopolitical tensions. Furthermore, the positive impact from lower rates would not be felt immediately as the refinancing of maturing debt is likely to remain a drag. The cost of such borrowings and accompanying interest rate swaps are still materially below current spot rates.
Despite the positive outlook, most of the S-REITs under the team’s coverage continued to see lower DPUs in the 2QFY2024 ended June due to higher borrowing costs and foreign exchange (forex) headwinds.
As such, the OCBC team has lowered its DPU estimates by 0.4% for FY2024 and by 1.0% for FY2025.
See also: With 300MW wind-solar project win in India, Sembcorp at 64% of 2028 renewable energy goal: CGSI
“Following these revisions, we expect S-REITs under our coverage to register average/median DPU growth of -2.7%/-2.0% for FY2024 due to the impact of higher financing costs, before staging a recovery of 3.6%/2.9% for FY2025,” it writes. “Our forecasts are 1.4% (average) and 0.9% (median) below consensus for FY2024, and 0.2% (average) and 0.6% (median) lower than consensus for FY2025.”
However, based on the team’s sensitivity analysis, every 100 bps decline in borrowing costs would impact its DPU forecasts by +3.1% for FY2024 and +3.0% for FY2025 on average.
In addition, the recent proposal by the Monetary Authority of Singapore (MAS) to simplify its leverage requirements by having all REITs stick to an aggregate leverage limit of 50% and a minimum interest coverage ratio (ICR) of 1.5 times would give the REITs more flexibility.
“Should this be implemented and coupled with the expected improvement in liquidity conditions ahead, this would provide more support to capital recycling activities, with industrial S-REITs best positioned for this, in our view,” the team writes.
With the upcoming rate cuts, the team thinks institutional investors are likely to put money into S-REITs, especially if the Singapore banks show signs of deterioration in asset quality and if the banks' net interest margins (NIMs) see a faster-than-expected contraction.
Among the REITs, the team likes the ones that are trading at undemanding valuations and are backed by strong sponsors. They also like REITs that have healthy financial positions that allow them to capitalise on capital recycling activities when liquidity conditions improve further. These REITs should also have some exposure to Singapore assets.
“The quality of S-REITs’ portfolios is dependent, in part, on their exposure to real estate for the future, as the built environment needs to evolve in response to secular megatrends such as technological disruptions and a growing emphasis on environmental, social and governance (ESG) to stay relevant,” says the team.
For more stories about where money flows, click here for Capital Section
“We believe S-REITs can capitalise on their home advantage and the allure of Singapore given the resilience and attractiveness of the city state’s real estate market,” it adds, noting that the city-state’s real estate market is buttressed by a politically stable environment, infrastructure enhancements and robust capital inflows to the commercial property market. Holding assets in Singapore will also help these REITs avoid forex fluctuations for income derived in Singapore dollars (SGD).
To this end, the team prefers logistics and industrial sub-sectors, followed by hospitality, retail and office, even it remains on the look out for signs of deterioration in the macroeconomic and other high frequency data, especially in relation to more cyclical sub-sectors like hospitality and office.
“We would also like to point out that well-diversified REIT portfolios should not avoid our less preferred sectors entirely, as there could still be selective opportunities,” they add.
Overall, the team has named Frasers Logistics & Commercial Trust BUOU (FLCT), CapitaLand Ascott Trust HMN (CLAS), Mapletree Industrial Trust ME8U (MINT), CapitaLand Ascendas REIT A17U (CLAR) and Parkway Life REIT C2PU (PLife REIT) as its top picks.
On the other hand, its least-preferred REITs are Suntec REIT T82U and Keppel DC REIT AJBU as they are trading above the team’s fair value estimates of $1.15 and $1.97 respectively as at Aug 22.
OCBC’s fair value estimates for FLCT, CLAS, MINT, CLAR and PLife REIT are $1.35, $1.08, $2.71, $3.23 and $4.29 respectively.
As at Aug 21, the FTSE ST All-Share Real Estate Investment Trusts Index (FSTREI) is trading at a forward P/B multiple of 0.9 times, or 1 standard deviation (s.d.) below its 10-year average of 0.98 times.
The index’s forward distribution yield is at 6.1%, which is in line with its 10-year average of 6.2%.
“With the 10Y Singapore government bond yield declining from a year-to-date (ytd) peak of 3.45% to 2.74% [as at Aug 21], the distribution yield spread between the forward distribution yield of the FSTREI and the 10Y Singapore government bond yield is at 340 bps, in line with the average of 338 bps over the past three years but 1 s.d. below the 10Y mean of 397 bps,” the team notes.
Preparing for the future
In the same report, the OCBC team identified several factors that can bring about several long-term benefits to REITs.
Technology is a key driver, particularly for data centre REITs, as demand continues to rise with increasing internet penetration, digitalisation, and cloud migration.
Other REIT sub-sectors also stand to gain. For instance, logistics and industrial sectors can leverage technology to achieve speed, accuracy and efficiency, which are key operational factors.
Meanwhile, retail REITs can tap on omnichannel strategies, which is essential to thrive in today’s retail landscape due to the rise of e-commerce consumption. Hospitality REITs also get to benefit from the rise of artificial intelligence (AI), which may help hospitality operators anticipate equipment maintenance needs and address them proactively.
Finally, with the shift towards hybrid work arrangements, office REITs can work with their tenants to use technology to revitalise their offices, focusing on improving employee comfort and productivity while also reducing a building's energy consumption. Operators can also look into transforming underutilised office space into coworking hubs, which can generate additional revenue and attract tenants seeking flexible work environments.
“As the digital landscape continues to evolve, REITs must carefully evaluate their capital expenditures (capex) allocated to technological advancements. This involves striking a balance between the benefits of technology and the associated risks, all while ensuring long-term value for unitholders,” the team writes.
ESG is another factor REITs should consider. Under the environmental or ‘E’ pillar, S-REITs which differentiate themselves by retrofitting assets with green initiatives and improving energy efficiency may enjoy rental premiums. This is especially so in markets where highly efficient, green-certified buildings are few and far in between. Conversely, S-REITs behind the curve may risk incurring a brown discount on both offering rents and valuations.
According to the OCBC team, green certification may also help lower vacancy risk.
“If a retrofit is required, especially for more specialised property in the logistics and industrials space, tenants are likely to sign longer leases in order to benefit from the additional investment over a longer period of time,” says the team. “As corporates gravitate towards leasing space that support or even accelerate their commitment to decarbonise, the tenant pool for buildings that are not green-certified will continue to shrink, translating to a higher risk of obsolescence and increased magnitude of brown discounts.”
Under the social or ‘S’ pillar, the team notes that social building features may play a growing role in valuations in the longer-term as it sees social value potentially being the next frontier in the real estate’s ESG transition.
Finally, having good corporate governance – the final pillar in ESG – is key to safeguard the interests of REIT unitholders.
“Critics argue that REIT managers are incentivised to increase assets under management (AUM) to earn more management fees, even if acquisitions do not necessarily improve unitholder value. A counter argument to that would be that the sponsor often holds a significant proportion of units in the REIT; thus, its interests are aligned with those of other unitholders,” suggests the team.
