- Financial metrics stay robust in the face of rising interest rates
- Interest coverage ratios remain comfortably above minimum levels based on our stress test analysis
- Valuations (and NAVs) are attractive; cap rate spread compression is not excessive while market upturn will drive asset reflation
- S-REITs to bottom out as rate lift-off approaches
Financial metrics remain robust. While we had in our previous report ascertained that DPU downside risk is limited to c.3.5% (1% hike in refinancing cost) given the sector’s diversified refinancing profile, we are further comforted that S-REITs’ interest coverage ratio (“ICR”) of 4.9x (ranging between 3.2x to 21.0x) is comfortably above the minimum 2.5x imposed by the Monetary Authority of Singapore (“MAS”) and possibly loan covenants. This implies that S-REITs have the flexibility to gear up towards the c.50% level if they choose to, although we sense that most managers are keen to keep gearing closer to the c.38%-39% level, providing headroom for opportunistic acquisitions. We have stressed tested our estimates and a 1.0% hike in interest rates will see ICR ratios dip to 4.3x (ranging between 2.5x to 18.0x), implying that S-REITs are well buffered against interest rates hikes.
Valuations may see upside as cap rate spreads are not excessively tight, ahead of expectations. We note that cap rates for various real estate classes have compressed by up to 100 basis points over the past decade. The tightest compression was seen in the industrial (logistics, business parks) and suburban retail sectors given their proven resilience throughout the COVID-19 crisis supported by increasing capital allocations from investors into these emerging asset classes. While cap rates are low, we note that cap rate spreads (cap rate minus 10-year yields) are still within historical range and not excessively compressed. As such, with rental growth picking up in 2022-2023, asset valuations should remain sticky or trend higher as portfolio net operating income (“NOI”) improves.
S-REITs offer value, trading below historical mean. Despite a 2.0% rise month-on-month as market risk-off sentiment sets in, 15 of 44 S-REITs still trade within 5% of their 52-week lows and forward yields are higher than their historical mean. As we approach rate hike lift-off in March’22, we remain buyers on weakness for the sector with a preference for re-opening plays (FCT, CICT,SUN,CLCT, ART) and selected high-growth industrial names (FLCT,MINT).