DBS Group Research analysts Derek Tan, Geraldine Wong and Dale Lai see Singapore REITs (S-REITs) continuing to attract flows with the anticipated interest rate cut by the US Federal Reserve (US Fed) in September.
While economists at DBS have maintained that there will be two 25 basis point (bps) cuts in 2024 from September through December, some market watchers are looking at cuts of up to around 50 bps in September, with a few even hinting at an emergency interest rate cut before the month.
The analysts see S-REITs in the retail, industrial, office and hotel sectors to benefit from the cuts, due to their abilities to deliver earnings surprises on resilient income generation ability.
According to their analysis, with S-REITs gradually dropping off hedges, every 100 basis points (bps) drop in interest rates should drive potential savings of around 2.4% for S-REITs in 2025, which they have not priced in.
Tan, Wong and Lai’s top five picks are retail trusts Frasers Centrepoint Trust J69U (FCT) and Mapletree Asia Commercial Trust (MPACT); industrial trusts CapitaLand Ascendas REIT A17U (CLAR) and Frasers Logistics and Commercial Trust (FLCT). These are the trusts that DBS believes are well-placed to deliver earnings surprises, on the back of resilient income generation ability as well as benefiting from decisively delivered interest rate cuts.
Within hotels, the analysts see the most value in CapitaLand Ascott Trust HMN (CLAS), given expected upside from its completing asset enhancement initiatives (AEIs) and acquisitions in 2HFY2024.
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“We turn more careful on hotels with expected softness in demand come 2HFY2024 as most hoteliers have become more price sensitive given the slower-than-expected pick-up in China demand.”
DBS’s target prices for FCT, MPACT, CLAR, FLCT and CLAS are $2.70, $1.75, $3.25, $1.44 and $1.15 respectively. The analysts retain its subsector preferences in the order of retail, industrial, hotels and office.
They write in their Aug 20 report: “While future pricing may be highly volatile and subject to change on how macro data-pans out in the coming months, with a close correlation between interest rates and REITs, we remain confident that S-REITs already saw their lows back in July and should see strength ahead.”
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In the 1HFY2024, S-REITs saw lacklustre dividend per unit (DPU) growth, with a sector-wide 7% y-o-y and 5% h-o-h drop in DPUs mainly due to erosion from higher interest costs.
As at June 30, S-REITs had an average borrowing cost around 3.9%, with borrowing costs inching up by around 10 bps over the past quarter, a marginal increase but close to the market S-REITs are borrowing at.
Therefore, the analysts believe that overall portfolio interest costs have largely been “marked-to-market”.
Assuming a typical three to five-year refinancing roll, despite the expected additional drop in base rates, Tan, Wong and Lai note that the refinancing spreads are likely to remain positive.
They write: “Our analysis indicates that re-financing spreads will remain around 50 bps in FY2025, even with a 100 bps reduction in benchmark rates.”
As their current estimates assume a “higher-forever” interest rate environment, the analysts have not factored in the impact of potential rate cuts into their projections.
“An overall 30 bps savings in all-in borrowing costs could lead to an around 2.4% upside to our earnings estimates for S-REITs, with major beneficiaries being Suntec REIT and OUE LJ3 Commercial REIT TS0U (OUECT).”
The DBS analysts conclude: “We anticipate further upside in FY2026 earnings even if there are no additional rate cuts beyond the projected initial 100 bps reduction.”
