Earnings/TPs trimmed on interest rate and cost rises
Funding cost concerns have gained prominence with the Fed’s steepening rate hike path. While balance sheets are strong, interest costs for S-REITs are set to rise after 1Q22. We factor in a more aggressive interest rate growth profile, and our DPUs/TPs fall by 2-8% as a result (Fig 1). Interest rate volatility remains high, with DPUs for industrial REITs better cushioned from further rate increases than office and hospitality. Sector fundamentals are improving into 2H22, with rents accelerating from demand growth and benign supply. We see capital recycling gaining pace, as fast-tracked divestment programs support acquisition pipelines. Our top BUYs are AREIT, CICT, CDLHT, and SUN as they trade at 5-6% yields and could deliver 5-22% DPU growth.
Rates on the rise, paring dividends, TPs
The S-REITs had anticipated higher rates and so pushed up their fixed-rate borrowings, to c.73% on average, while gearing stayed low at c.37%, and interest cover manageable at c.5x. The sector’s borrowing costs likely bottomed in 1Q22, and could increase by 100bps for floating-rate debt (vs +50bps), as our year-end 3M SIBOR and 3M SORA forecasts are raised (see Singapore Economics 23 May 2022 – Core Inflation Hits Decade High in April; Raise 3M SIBOR & SORA Forecasts). This is predicated on the Fed hiking a total of +275bps this year. Assuming rates rise a further 50bps above our new base case, then DPUs could fall by another 1-5%, with the industrial REITs less sensitive due to lower gearing and higher fixed-rate debt.
Watching margins, eyeing growth
Core CPI, having climbed to a decade high in April from surging electricity and gas prices, highlights near-term margin pressures for REITs with concentrated Singapore AUM. Electricity expenses represent 2-15% of opex for many REITs, but their margins are largely cushioned, with costs for some, recoverable from tenants due to pass-through leases, while others could see <5% lower FY22-23E NPIs/DPUs. We expect the stronger-than-expected lift in revenues from higher rents and sales contribution for the commercial and hospitality REITs to offset their higher costs in FY23E.
Resilient occupancies, stronger rental outlook
We see improving sector metrics with resilient occupancies and recovering rents. Increasing leasing momentum and tight vacancies should underpin a stronger rental growth outlook, especially as office landlords gain pricing power against tight supply. We maintain our rental growth forecasts, led by a 13% 2-year CAGR for office rents, and 6% for retail assets. Industrial rents have bottomed, and should climb at 2-5% pa. RevPARs could jump 13-17% YoY in 2022-23, with upside risk from China’s re-opening.