UOB Kay Hian analyst Jonathan Koh has kept his “overweight” rating on Singapore REITs (S-REITs) after interest rates seem to have peaked.
The US Federal Reserve has paused its rate hikes for the third consecutive Federal Open Market Committee (FOMC) on Dec 13 and is set to commence rate cuts in 2H2024.
Based on the dot plot, the Fed Funds Rate is expected to be at 4.6% by the end of 2024 down from 5.1% previously and 3.6% by the end of 2025, down from 3.9% before. This indicates cuts of 75 basis points (bps) in 2024 and 100 bps in 2025.
As the Fed turned dovish with inflation in the US receding, S-REITs finally outperformed by 7.7% in 4Q2023 after many years of tribulations since the Covid-19 pandemic.
In 2020, the sector suffered a negative total return of 3.6% and underperformed by 8.1% in 2021 as inflation began to rise then. In 2022, the sector underperformed by 19.1% as the Fed Funds Rate increased from 0% to 4.25%. Selling pressure in S-REITs then came to a head when it underperformed by 6.1% in 3Q2023 due to fears that interest rates would stay higher for longer.
As inflation moderates, bond yields have tumbled. The US 10-year government bond yield fell by 69 bps to 3.88% in 4Q2023 due to the positive outlook for continued moderation of inflation. Similarly, the Singapore 10-year government bond fell by 69 bps to 2.71% at the same time, reflecting financial stability in the country. Meanwhile, the yield spread for S-REITs expanded by 29 bps to 2.74% in 4Q2023, Koh points out.
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On the whole, the sector is a defensive one that could “weather ongoing geopolitical uncertainties and potential slower economic growth”.
Within the sector, Koh recommends investors focus on blue chip S-REITs that have resilient balance sheets to cope with the external uncertainties.
In his report dated Jan 3, the analyst has identified his top picks. They are: CDL Hospitality Trusts J85 (CDLHT), CapitaLand Ascott Trust HMN (CLAS), Keppel Pacific Oak US REIT (KORE), Keppel REIT (KREIT), Lendlease Global Commercial REIT JYEU (LREIT) and Mapletree Industrial Trust ME8U (MINT).
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He has given all the REITs mentioned “buy” calls with target prices of $1.57 for CDLHT, $1.40 for CLAS, 59 US cents (78 cents) for KORE, $1.17 for KREIT, 89 cents for LREIT and $2.98 for MINT.
For the REITs in his coverage, Koh has raised his target prices by an average of 11.4% after adjusting his risk-free rate lower by 50 bps to 2.75% from 3.25% previously.
“For US REITs, we have lowered risk-free rate by 50 bps from 4.5% to 4.0%. Our target prices for US REITs have similarly been raised by an average of 6.8%,” he says.
Further to his report, Koh says he likes CDLHT with its higher revenue per available room (RevPAR) for its Singapore hotels in the 3QFY2023 ended Sept 30, 2023 and for the additional contributions that will be made in the 2HFY2023, FY2024 for Grand Copthorne Waterfront Hotel and The Casting in Manchester, UK.
CLAS’s portfolio occupancy is expected to see improvement in the 2HFY2023 ended Dec 31, 2023 and the FY2024 due to the recovery and normalisation in business and leisure travel. The trust will also benefit from the recent expansion in longer-stay properties such as its student accommodation property in the UK and its rental housing property in Japan.
KORE, which focuses on growth cities attract in-migration, such as Austin, Dallas, Denver and Nashville in the US, saw both portfolio and physical occupancies grow on a q-o-q basis in the 3QFY2023 ended Sept 30, 2023. Its adjusted net property income (NPI) grew organically by 5% y-o-y due to positive rental reversion of 3.8% and built-in rental escalation of 2.5%. As at end September 2023, KORE’s aggregate leverage stood at a healthy 39.1%. “KORE trades at an attractive FY2024 distribution yield of 12.9% and P/NAV of 0.47x (53% discount to net asset value (NAV) per share of 78 US cents),” says Koh.
KREIT, the only pure-play office REIT listed on the Singapore Exchange S68 (SGX) achieved positive rental reversion of 10.7% in the 3QFY2023 ended Sept 30, 2023. It has backfilled vacant spaces ahead of new supply coming on-stream in 1QFY2024, notes Koh. At present, its valuation is attractive with FY2024 distribution yield at 6.1% and P/NAV at 0.70 times.
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LREIT achieved a strong positive rental reversion of 16.3% and 99.7% committed occupancy for retail properties for the 1QFY2024 ended June 30, 2023, which is a plus in Koh’s book. Its mall, 313@Somerset, will benefit from the return of tourists while the development of a multi-functional event space at Grange Road carpark would attract higher shopper traffic, he adds. “LREIT has the option of divesting the office block at Jem combined with a private placement to redeem perpetual securities of $400 million. We estimate the negative impact to be manageable at 3.8% for [the REIT’s] distribution per unit (DPU) and 2.3% for NAV per unit for the deleveraging. LREIT provides an attractive FY2024 distribution yield of 6.9%,” says Koh.
MINT, which saw a healthy aggregate leverage of 37.9% as at end-September 2023, provides growth from data centres at a “reasonable price” with an FY2025 distribution yield of 5.5%. The REIT has managed to expand to Japan’s data centre market and plans to recycle its assets in Singapore through the divestment of its business park and flatted factories to finance the enlargement of scale in Japan. MINT is also close to securing a replacement tenant for its data centre at Brentwood, Tennessee when AT&T’s lease expires in November 2023, says Koh.
Units in CDLHT, CLAS, KORE, KREIT, LREIT and MINT closed at $1.10, 97.5 cents, 34 US cents, 92.5 cents, 63.5 cents and $2.50 respectively on Jan 4.
