- Turning constructive on S-REITs as correction throws up value
- Impact of interest rates (critical factor) is more muted than what markets are pricing in and expect
- A 100-basis point hike will only cut distributions by 3.5%, or lead to a 20bps reduction in yield, keeping yield spreads still above 4.0%
- Maintain preference for re-opening plays but industrial REITs throw up good value at current levels
Turn constructive on S-REITs. S-REITs and interest rates are closely intertwined. Priced off 10-year yields, the recent share price weakness in S-REITs has widened the sector’s yield spread to c.4.2%, which is close to -1 standard deviation (SD) of its 10-year mean. With markets penciling in five hikes by the Fed through 2022, according to Bloomberg’s consensus, we believe that the Fed’s hawkish stance is substantially priced in at current levels. We turn constructive on the S-REITs’ current levels and advocate for investors to start to accumulate on the back of strengthening fundamental datapoints noted in recent results and meetings.
Analysing interest rates as a critical factor: Are investors over-estimating the impact of fed hikes on S-REITs? While refinancing rates are likely to be higher going forward, we believe that the impact is manageable and not as large as investors fear. We see ample defences put up by S-REITs and are confident that the impact of interest rate hikes will be more muted than expected. With a diversified weighted average debt expiry profile (“WADE”) of 3.1 years and renewing only c.30% of its debt in FY22-23F, there are minimal concentration risks, in our view. In fact, a hike of 100 basis points (“bps”) in interest costs will take more than three years for the REIT to feel the full impact on distributions. S-REITs have also hedged in 70% of their interest costs in fixed rates, further minimising the impact of higher rates on distributions. We estimate that a 50bps and 100bps hike will cut FY22F distributions by only 1.8% and 3.5%, respectively, which implies a maximum cut of 20bps in the headline yields of c.6.0%.
Increasing confidence on robust growth returning. With stronger economic growth accompanying higher interest rates, we continue to prefer S-REITs with stronger DPU growth profiles. We see strong domestic retail sales driving a c.5-6% rise in DPUs for retail and selected commercial S-REITs (we prefer FCT, LREIT, SUN, CICT, CLCT). We like plays like ART for its larger domestic exposure and its pivot to the student accomodation sector. Industrial S-REITs have thrown up good value in large caps but we maintain our preference for FLCT and MINT for its acquisition visibility.
Key risk. A 50bps hike in March and unforeseen slowdown in economic activity.