To achieve a sustainable passive income, investors should focus on the long-term outlook of S-REITs. In this article, we provide an update on the S-REITs sector.

  • For the first half of 2021, office and retail S-REITs have outperformed industrial and data centre S-REITs thanks to the rotation to value stocks.
  • After the decent run up in the share price of Keppel REIT (SGX:K71U), we think it is time for investors to sell the stock.
  • With rising vaccination rates, hospitality REITs with a larger exposure to domestic travel demand should be able to outperform. Our pick for this sub-segment is ARA US Hospitality Trust (SGX:XZL).
  • We generally prefer the industrial and data centre sub-segments due to their stronger fundamentals. We expect them to deliver resilient growth, supported by structural trends accelerated by the pandemic. Our pick is Ascendas REIT (SGX:A17U).

The tables have turned. For the first half of 2021, office and retail S-REITs have outperformed industrial and data centre S-REITs (Figure 1). Last year’s losers came out stronger thanks to the market rotation into value stocks on the back of an economic recovery. This is despite the increasing adoption of a hybrid work model and the persistent lack of tourists in downtown malls.

Looking ahead, we continue to hold the view that the S-REIT sector is in for an uneven recovery. In this article, we provide an update on the sector.

Figure 1: Total return of sub-segments

Office: Is a storm brewing?

Share prices of office REITs have done well so far this year despite a challenging leasing environment. Tenants have been reassessing their future office needs as they adopt a hybrid work model. Historically, financial firms have been the main driver of office demand in Singapore. Today, the same firms have been cutting their office spaces in the central business district (CBD).

Demand from the tech sector, although strong, may struggle to fully absorb the supply in the pipeline and spaces left behind by other sectors. As estimated by Cushman & Wakefield, the financial sector is likely to release at least 500,000 square feet of office space by 2022. For example, DBS plans to give up 75,000 square feet of space at Marina Bay Financial Centre, which is equivalent to 2.5 floors. That is approximately only one-sixth of the total space that the financial sector is potentially letting go.

As a result, vacancy rates could continue to increase and put a downward pressure on rental rates (Figure 2). Office landlords in the CBD could also continue to see a downward trend in occupancy rates.

Figure 2: Vacancy rates have been rising

With the gloomy outlook for offices, investors holding on to Keppel REIT (SGX:K71U) should consider reallocating their money elsewhere.

Fundamentals of Keppel REIT (KREIT) remain weak despite the recovery in share price. Financial firms, who are at risk of downsizing, make up its largest tenant sector. The sector occupies 32% of net leasable area, which is one of the highest among the office S-REITs. Additionally, several anchor tenants are financial firms. Non-renewals would likely have a noticeable impact on the income as well as occupancy rate.

As rental rates and occupancy rates remain under pressure, we also expect portfolio valuations to trend downwards. Hence, investors should not purely look at the current PB ratio as it is likely to trend upwards after accounting for property revaluations (Figure 3). It is also worth highlighting that KREIT’s current PB ratio is already above its historical average, suggesting that valuations are expensive.

Figure 3: PB Ratio could moderate

Additionally, there are other more resilient REITs out there which are offering similar, if not, higher levels of yields as compared to KREIT’s 5.0% (Table 2). KREIT’s forward yield is also below its historical average (Figure 4), which once again, support our stance that it may not be the best investment idea at this juncture.

Lastly, at our estimated fair value of SGD 1.01 arrived using a dividend discount model (Figure 5), the potential downside is -15% based on the closing price on 9 July 2021.

Office S-REITs are also made up of those who are focused on US office properties. While these REITs have been relatively more resilient, they are not immune to downsizing. The tech sector has been the main driver of US office demand since 2013. However, tech employees have been wanting more work flexibility and their companies are likely to be looking for more flexible office lease terms. Moving forward, leases signed may be shorter, which would affect the income stability and potentially, the occupancy of landlords.

The best-performing US focused office S-REIT, Keppel Pacific Oak US REIT (SGX:CMOU), has delivered a YTD total return of 19%. We expect strong tech demand to drive single digit positive rental reversions. Even after the run up, its average forward yield is one of the highest in the S-REIT sector, at 7.8%. Key downside risks to take note of would be rising vacancy rates and continued uncertainty over the future of office.

Retail: Not out of the woods

The DPU growth of retail REITs came in strong this year due to a low base effect. However, retail REITs are in for a challenge in the longer term, as the accelerated growth of e-commerce is a negative structural trend for many physical retailers. That being said, suburban retail REITs with higher exposure to defensive retail offerings, including F&B outlets, and experiential trades would be more resistant to e-commerce.

Thus far, suburban malls have been more resilient with rental rates remaining fairly stable, while downtown retail rental rates have been under pressure ever since the start of the pandemic (Figure 6).

Figure 6: Suburban retail rental rates have been more resilient

Source: CBRE, Frasers Centrepoint TrustData as of 31 March 2021
However, with the COVID-19 situation still fluid, retail REITs face several downside risks. This includes the tightening of restrictions, temporary closure of malls should there be any COVID-19 clusters, as well as rental waivers. Against this backdrop, we believe that there are better opportunities in other sub-segments, which we will be highlighting below.

Hospitality: Long but gradual recovery

International travel still faces a long road to recovery. On a positive note, domestic travel has come alive in overseas markets and is recovering at a much faster pace than international travel.

We are positive on ARA US Hospitality Trust (SGX:XZL), which replaces Ascott Residence Trust (ART) as our recommended hospitality REIT. While ART does have a good exposure to countries with sizable domestic markets, we believe that ARA US Hospitality Trust (ARA UST) will be able to outperform.

Thanks to high vaccination rates and the recovery in consumer confidence, the US hotel market has seen a pick-up in domestic demand, resulting in record high revenue per available room (RevPAR) since the pandemic. We believe this will benefit ARA USHT which holds a portfolio of hotels predominantly serving the US domestic market. Our target price of USD 0.63 represents an upside potential of 10% as of 9 July 2021.

Figure 7: Recovery of the US hotel market

Industrial & Data Centre: Our preferred sub-segment

Despite the rotation away from defensive industrial and data centre REITs, their fundamentals remain strong. We believe they are positioned to deliver resilient growth, supported structural trends accelerated by the pandemic such as the shift towards e-commerce and growing adoption of cloud services.

For investors who solely want to invest in data centres, the only option currently available in the local market is Keppel DC REIT (SGX:AJBU). As the top performing S-REIT in 2020, Keppel DC REIT (KDC) has had a great run.

Even with the recent share price weakness, KDC is trading at a PB ratio of 2.2X, which is still at a considerable premium to the industrial REITs, some of which have been increasing their exposure to data centres (Figure 8). Besides, if Digital Realty manages to list its data centre trust in Singapore, KDC would not be the only data centre S-REIT. Moreover, at an average forward yield of 4.2%, we think that KDC is not compelling to investors who are seeking higher yields.

Figure 8: KDC’s premium has widened over the years

As such, we believe investors can consider other defensive REITs with lower data centre exposure that can provide higher yields and more value. Investors should keep in mind that data centres are not the only real estate asset class that is expected to benefit from structural trends.

Logistics properties are another growing asset class due to the acceleration of e-commerce that will drive demand for warehouse spaces, supporting the long-term growth in rental rates. Ascendas REIT (SGX:A17U), who has delivered a YTD total return of 1%, is one of the defensive REITs to consider.

Ascendas REIT (AREIT) offers an average forward yield of 5.5% – the most attractive out of all blue chip industrial REITs. Earlier this year, AREIT boosted its exposure to data centres through the acquisition of 11 data centres in Europe. While the exposure is relatively low, AREIT does have a good amount of exposure to logistics properties.

Additionally, AREIT has a strong inorganic growth visibility. Its gearing ratio of 38.0% as of 31 March 2021 leaves a debt headroom of approximately SGD 3.8 billion for future acquisitions, allowing it to continue future-proofing its portfolio.

Figure 9: AREIT Share Price vs DPU


As the COVID-19 pandemic has altered several structural trends, we believe S-REIT investors should focus on the long-term outlook in order to achieve a sustainable passive income.

Supported by the strong recovery of cyclical REITs, valuations of the S-REIT sector are also reaching pre-COVID levels (Figure 10). This is despite an uneven recovery across the board as well as a cloudy outlook for certain sub-segments.

As such, we would like to reiterate that investors should be selective when investing within the S-REIT space. We generally prefer the industrial and data centre sub-segments due to their stronger fundamentals.

Figure 10: PB of the FTSE ST REIT Index