Weighing The Odds – Upside From Reopening Against Perceived Threat From Inflation
Nascent signs of easing of inflationary pressure have emerged. The yield curve
steepened again in May 22 and is currently upward-sloping, suggesting a soft landing.
Economic expansion, if sustained despite geopolitical uncertainties, is positive for SREITs. We stay invested in hospitality, retail and office REITs as reopening plays. BUY
ART (Target: S$1.25), FCT (Target: S$2.79), FEHT (Target: S$0.78) and LREIT (Target:
S$0.96). Maintain OVERWEIGHT.
WHAT’S NEW
• Freedom Day marks an orderly full-fledged reopening. The easing of restrictions in Apr
22 marks the start of Singaporeans living with COVID-19 as an endemic disease. The
easing benefits all sub-sectors of the S-REIT market, including hospitality, retail and office.
Singapore’s international borders are fully reopened to vaccinated travellers with the launch
of the Vaccinated Travel Framework. Food & Beverage establishments are operating at full
capacity as the cap on group size of 10 persons was lifted. All employees are allowed back
to their workplaces.
• Nascent signs of easing of inflationary pressure have emerged. US core PCE inflation
peaked at 5.3% in Feb 22, the fastest pace in 30 years. Core PCE inflation eased 0.3ppt
mom to 4.9% in Apr 22. The easing of inflationary pressure coincided with a pick-up in
economic activities after new cases of the Omicron variant subsided. Implied inflation based
on five-year Treasury Inflation-Protected Securities (TIPS) moderated from a peak of 3.6%
in mid-April to the current 2.9%. The Congressional Budget Office expects CPI to ease to
4.7% in 4Q22 from 8.3% in Apr 22.
• Yield curve indicates a soft landing. We expect a series of three successive 50bp hikes
on 4 May 22, 15 Jun 22 and 27 Jul 22, followed by three successive 25bp hikes in
September, November and December. US Fed Funds rate would thus hit 2.5% at end-22.
The yield curve inverted temporarily in Apr 22, suggesting a potential slowdown. It
steepened again in May 22 and is currently upward-sloping. Current short-end of the yield
curve implies forward short-term interest rates at 2.1% for 1Y, 3.1% for 2Y and 3.1% for 3Y.
The economy seems to be coping with external shocks.
• Commercial real estate is an important hedge against inflation. Landlords could raise
rents to keep abreast of inflation. Higher cost of construction reduces the competition for
constrained future new supply. Appreciation in capital value could also lower loan-to-value
ratio for mortgage debts. Landlords’ ability to pass higher rents to tenants depends on
fundamental factors, such as location of properties, demographics, migration trends,
demand/supply dynamics and vacancy rate.
ACTION
• Adapting to changes in macroeconomics and geopolitics. S-REITs are not out of the
woods yet but the gradual easing of inflationary pressure provides some respite. In light of
the elevated government bond yields and inflationary pressure potentially pushing rents
higher, we have utilised a higher risk-free rate of 3.0% (previous: 2.0%) and pushed terminal
growth higher by 0.8ppt in our DDM valuations for S-REITs. On average, we have adjusted
target prices for 20 S-REITs under our coverage lower by 5%.