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July 2024
S-REITs – Down but not out
The Singapore REITs (S-REITs) sector has remained an underperformer year-to-date (YTD), with the FTSE ST All-Share Real Estate Investment Trusts Index (FSTREI) recording total returns of -10.8% (as of 28 June 2024), paling in comparison to both the STI and MSCI Singapore Index, which achieved respective returns of 5.7% and 12.0% during the same period.
We believe share price performance of the S-REITs sector remains closely tied to movements in the 10-Year (10Y) US Treasury (UST) yield and the 10Y Singapore government bond yield, which have rebounded from end-2023 levels.
However, recent soft US labour market data and May’s US consumer price index (CPI) print have provided some reprieve as yields retraced from YTD peaks. We expect near-term sentiment of the S-REITs sector to remain heavily influenced by economic data, which has a bearing on the movements of UST yields.
Our house view is for two rate cuts by the Federal Reserve (Fed) in 2024. However, we also note that the outcome of the US elections and other risk factors may pose upside risk to Treasury yields. As such, our forecast for the 10Y UST yield has been raised from 3.75% to 4.25% over a 12-month horizon. Amidst the volatility, we believe the pullback in S-REITs’ share prices create buying opportunities for the quality names, but investors may also need to be more patient for a rebound in S-REITs' share prices if Treasury yields remain elevated.
Continued pressure on DPU
Most of the S-REITs under our coverage which reported distribution per unit (DPU) data for the 1Q2024 earnings season continued to exhibit weakness, with aggregate DPU declining on a Year-on-Year (YoY) basis.
The culprits were once again higher borrowing costs, currency headwinds and enlarged unit bases, which offset improvements in net property income (NPI) and capital distributions from divestment gains.
Out of the nine S-REITs under our coverage which disclosed DPU data, six declared lower YoY DPU ranging between -1.1% and -13.7%, while the remaining three achieved growth in the low-single digit range. Overall average and median DPU growth came in at -1.8% and -3.2% YoY respectively, for the reporting period.
Mild deterioration of credit metrics
Overall credit metrics showed a mild deterioration sequentially for the S-REITs under our coverage.
Aggregate leverage ratio on average increased by 0.3 percentage points Quarter-on-Quarter to 38.5%, as of 31 Mar 2024, while there was also an increase in average cost of borrowing by 12 basis points (bps) sequentially to 3.37%.
Most REIT managers are still guiding for their debt cost to increase further by the end of the year, due to higher refinancing costs from maturing debt. The impact will be partially mitigated by an increase in the proportion of debt that’s hedged, which rose from 77.1% (as of 31 December 2023) to 77.7%.
Based on our sensitivity analysis, for every 100bps increase in borrowing costs, the impact to our DPU forecasts would be -3.0% for FY1, and -2.9% for FY2 on average, which is slightly more negative than our sensitivity analysis done previously in February 2024.
Besides a small handful of S-REITs with interest coverage ratio below 2.5x, which is the minimum threshold required in order to have an aggregate leverage ratio limit of 50%, most S-REITs have healthy coverage ratios, with the average of those under our coverage coming in at 4.1x, as at 31 Mar 2024. Capital recycling remains key in an era of elevated interest rates, and we believe industrial S-REITs remain best positioned for this.
Valuations still supportive
From a valuation viewpoint, the FSTREI is trading at a forward price-to-book (P/B) multiple of 0.84x (as of 28 June 2024), which is 1.9 standard deviations (s.d.) below its 10Y average of 0.99x.
Forward distribution yield is at 6.6%, which is 0.8 s.d. above its 10Y average of 6.2%.
As the 10Y Singapore government bond yield currently stands at 3.26% (as at 27 June 2024), the distribution yield spread between the forward distribution yield of the FSTREI and the 10Y Singapore government bond yield is at 333bps, or 1.1 s.d. below the 10Y mean of 398bps.
Conclusion
In terms of positioning, from a bottom-up stock picking strategy, we like S-REITs backed by strong sponsors, are in healthy financial positions with room for capital recycling, and have at least some Singapore asset exposure.
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