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REITs of Passage - How to get passive income from investing

REITs of Passage - How to get passive income from investing

  • 30 June 2021
  • By OCBC Singapore
  • 15 mins read

Investments merits of REITs

Where investing for income is concerned, attention invariably turns to investments that are able to deliver a consistent stream of dividend payments. Among the more reliable sources of investment income is real estate investment trusts, or REITs.

From the outset, REITs offer a number of advantages.

  • First, this asset class offers a liquid vehicle through which to invest in income-generating real estate without having to own the actual illiquid properties.
  • Second, it allows investors to diversify income streams across different asset classes and regions.
  • Third, REITs are particularly well-suited for income seekers due to the recurring and regular distribution of income either quarterly or semi-annually. There is some certainty in the regularity of pay-outs as well, as REITs are required by law to redistribute at least 90% of their taxable income each year i.e., pay it out via dividends.
  • Fourth, these physical assets are professionally managed, with assets held under a trustee.
  • Lastly, with REITs, investors can earn from both the regular distribution of income and potential capital appreciation in the stock price. In a sense, REITs are akin to a bond trading like a stock.

Read on to find out which REITs are worth investing in amid the COVID-19 crisis.

Chart 1: Structure of a REIT

Source: Bank of Singapore

Sometimes investing in property is best done indirectly

Since REITs essentially buy properties and earn rental income from the tenants of these properties, a question beckons: Why not just buy property directly and earn the rental income?

  • From the outset, physical property is neither liquid nor cheap. You are not able to sell it as easily as you could other financial assets and it requires a huge financial outlay. Properties like shopping malls are just prohibitively costly to access for the average investor.
  • Secondly, property investing comes with concentration risk as invariably the bulk of your portfolio will be tied to a single illiquid asset and the outlook of the local property market, which is more often than not, largely determined by government regulation which itself is unpredictable. This is before factoring the cost of maintaining the property, and other costs related to finding tenants.
  • Thirdly, by putting down huge sums to secure a property investment, you are essentially foregoing other potential investments that are more liquid and may be higher yielding in nature.

As can be gleaned from Chart 2, investing in financial assets in Singapore would have yielded better returns, albeit with more volatility, versus investing in physical property over a span of 20 years.

Chart 2: Singapore private property price appreciation versus equity indices over past 20 years
Equities generated highest capital appreciation in the long term, albeit with higher volatility.

Source: Bloomberg, data as at 22 April 2021

REITs are generally prized for their defensiveness in bad times

REITs are not just valued for the access it gives investors to illiquid properties or for the regular income it pays out. Generally, they play a useful role as defensive assets in portfolios and are typically favoured by investors when market conditions worsen and risk sentiment falter.

REITs also receive a boost when interest rate expectations are low and demand for less risky, income yielding assets is high.

Singapore REITs (SREITs), for example, has outperformed the broader market during episodes of heightened risk aversion. We saw this play out in 2019 during the height of the US-China trade war and the recession in the US manufacturing sector.

Chart 3: FTSE Straits Times REITs Index versus the broader market
During periods of heightened risk aversion in 2019, REITs outperformed the broader market.

Source: Bloomberg, data as at 22 April 2021

Covid-19: A unique crisis

Yet, if one looked back just a year ago, this was far from the case despite the flight to safety as risk aversion peaked. Admittedly, 2020 was unique in the sense that the pandemic-triggered recession was the result of widespread economic shutdowns that shuttered businesses, confined individuals to their homes, and turned bustling cities, once teeming with life, into vacant lots. This strongly impacted tenant sales and hurt rental income of most properties. Office space and retail malls were deserted for a period a time, affecting a key source of revenue of REITs.

To ease the uncertainty during the challenging Circuit Breaker period, the Singapore government launched a bevy of support measures to help both renters and property owners. This included rental reliefs, cash grants for small businesses and interagency support for REITs. Distributions were cut as operating income shrunk.

A year later, the outlook for SREITs had improved as normalcy slowly returned to the island city state and vaccinations became widespread.

As a consequence, the share price of REITs had recovered significantly from the lows of 2020 to near pre-pandemic levels.

Chart 4: FTSE Straits Times REITs Index versus Straits Times Index
Not back to pre-pandemic highs yet, but close

Source: Bloomberg, data as at 28 June 2021

An asset for all seasons

To characterise REITs as a purely defensive play -- 2020’s correction notwithstanding -- would be to miss a broader point. From a historical total return perspective, SREITs boast a rather solid performance track record, in both good times and bad. Only until recently, SREITs have consistently bested the broader market on a cumulative and annualised total return basis.

Chart 5: Cumulative and annualised total return
Overall, good performance track record in both good times and bad

Source: Bloomberg, total return calculated as at 31 March 2021

On a regional level, SREITs had also outperformed other major REIT markets around the world (in local currency terms) including the US, Australia, Japan and Europe, at the height of the Covid-19 crisis last year, as a testament to its resilience. We expect the same resilience to help the sector recover from any Phase 2 (Heightened Alert) setback.

Chart 6: Year-to-date (YTD) total returns of major REIT markets (as at 28 June 2021)

Source: Bloomberg, data as at 28 June 2021

Near-term drivers

In the near-term, two catalysts remain in place that should keep demand for REITs well-supported.

First, REITs may still get a boost from countries steadily reopening their economies for business. With the rollout of vaccination programmes globally, we expect a gradual return to normalcy from 2H2021 onwards. This will likely benefit REITs as footfall and tenant sales in shopping malls gradually recover while physical occupancies in offices increase with the gradual relaxation of social restrictions.

Following the new Covid-19 measures in Singapore, there could be downside risks to our forecasts, depending on how the situation develops.

Logistics and data centres will continue to benefit from the tailwinds of higher e-commerce penetration rates and widespread adoption of technology -- secular growth trends that have only accelerated with the pandemic. Underlying operational improvement of SREITs should help to drive a re-rating over the medium to longer term.

Second, even while US Treasury yields have risen and could continue to rise more, nominal yields remain at historically low levels and real yields are still negative. This, alongside the generally dovish interest rate environment, should continue to drive the hunt for yield, in which case REITs are poised to benefit.

For one, SREITs offer higher dividend yields relative to the broader market and even against peers in the US and Europe. Nevertheless, as 2020 showed, dividends are not sacrosanct. Hence a bottom-up stock picking strategy to evaluate the longer-term sustainability of dividend payments should be a key consideration.

SREITs had performed reasonably well in the first quarter of this year, which translated into higher valuations. Another reason to remain slightly cautious in the near-term is due to volatility, which is likely to remain a fixture of the current trading environment.

Chart 7: 8-year forward price-to-book trend of FTSE Straits Times REITs Index
Valuations are no longer as appealing

Source: Bloomberg, data as at 28 April 2021

Chart 8: Yield spread between FTSE Straits Times REITs Index and Singapore government 10Y bond yield
The rise in the Singapore government 10-year bond yields have compressed spreads.

Source: Bloomberg, data as at 28 April 2021

Don’t pay too much for income. Stay selective amid higher valuations.

Given that valuation metrics are not outright cheap, selectivity matters. After all, not all SREITs are created equal. The dampening effects of the Covid-19 pandemic have created challenges for the real estate sector, some of which are structural in nature. On the other hand, opportunities have also emerged and provided tailwinds for others.

In this, investors should pay careful attention to the growth potential of the underlying properties and the sectors and segments in which they operate. This is key to gain exposure to long-term winners.

Due to the Covid-19 crisis, we think it is useful to categorise the broad SREITs space into two key camps or baskets:

  • Recovery basket: This would comprise retail and hospitality REITs that are more sensitive to the economic winds and are well positioned to benefit from the rotation to value and cyclical stocks globally (highlighted in orange).
  • Resilience basket: These are high-quality SREITs which are expected to be beneficiaries of secular growth trends with room for solid inorganic growth opportunities over the long-term (highlighted in blue).

Depending on where an investor’s interest and priorities lie as it pertains to their portfolios, they may look at quality picks in these two baskets.

Table 1: OCBC Investment Research (OIR) SREITs coverage

Source: Bloomberg, OCBC Investment Research estimates, extracted from the “Weekly SREITS Tracker” report dated 21 June 2021

Against this selection, we believe increased digitalisation and e-commerce penetration rates have boosted demand for data centres and modern logistics properties.

We believe this bodes well for the following SREITs as at 21 June:

Name

Description

Fair Value
(correct as at 21 June 2021)

Keppel DC REIT

  • Keppel DC REIT is a strong proxy to growing demand for data centre space, underpinned by increasing digitalisation and cloud adoption trends.
  • Its tenants come from fast growing industries such as internet enterprise, information technology services, telecommunications and financial services.
  • It is also one of the most defensive REITs given its long portfolio weighted average lease to expiry of ~6.6 years.

S$3.32

Ascendas REIT

  • Ascendas REIT (A-REIT) is the largest listed industrial REIT on the Singapore Exchange based on asset size and market capitalisation.
  • It has significant exposure to the business & science parks segment, where there is limited upcoming supply. A-REIT also has assets in Australia and UK and has recently proposed to acquire a portfolio of 28 business park properties in the US, which would mark its maiden entry into this market.
  • It has a diversified pool of quality tenants and its sponsor is CapitaLand Limited.

S$3.84

Source: OCBC Investment Research, extracted from the latest available research notes at the time of writing, as at 21 June.

Within the logistics space, we like the following SREITs as at 21 June:

Name

Description

Fair Value
(correct as at 21 June 2021)

Frasers Logistics & Commercial Trust

  • Frasers Logistics & Commercial Trust operates as a real estate investment company.
  • The company is a multi-national owner and manager of logistics and commercial properties.

S$1.62

Mapletree Logistics Trust

  • Mapletree Logistics Trust is Singapore’s first Asia-focused logistics real estate investment trust.
  • It has years of experience and strong expertise in the investment and asset management of logistics properties in Asia Pacific.
  • Its assets are strategically located near major expressways and key logistics clusters.
  • It has a growing and diverse base of quality tenants, spread across various industries ranging from food and beverage products, healthcare to electronics and IT.

S$2.10

Source: OCBC Investment Research, extracted from the latest available research notes at the time of writing, as at 21 June.

The rise in e-commerce penetration rates may have boosted demand for logistics assets, but it has also posed structural challenges for the retail sector. That said, we believe that brick and mortar retail and online retail need not be a zero-sum game, as an omnichannel strategy can enhance a customer’s shopping experience in both an offline and digital format.

The following are names which we believe are adapting to stay relevant:

Name

Description

Fair Value
(correct as at 21 June 2021)

CapitaLand Integrated Commercial Trust

  • CapitaLand Integrated Commercial Trust (CICT) is the largest S-REIT by market capitalisation and assets in Singapore.
  • It has a strong sponsor in CapitaLand Limited, and its scale has been significantly enlarged following the completion of the merger with CapitaLand Commercial Trust in Oct 2020.
  • CICT now offers investors diverse exposure to the suburban and downtown retail market and core CBD office sector in Singapore, coupled with a small exposure to Germany.

S$2.51

Frasers Centrepoint Trust

  • Frasers Centrepoint Trust (FCT) is one of the largest suburban retail mall owners in Singapore.
  • These malls include Causeway Point, Northpoint City North Wing (including Yishun 10 Retail Podium), Changi City Point, Waterway Point (40%-interest), Tiong Bahru Plaza, White Sands, Hougang Mall, Century Square and Tampines 1.
  • These retail malls are near homes and within minutes to transportation amenities.

S$2.78

Source: OCBC Investment Research, extracted from the latest available research notes at the time of writing, as at 21 June.

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