UOBKH: Singapore REITs (Overweight)

Strength Of Balance Sheet Being Stressed And Tested

The rapid surge in interest rates affects S-REITs who have not adequately hedged their
cost of borrowings. We cut DCREIT’s 2023 DPU by 15% but upgrade the S-REIT to BUY
after the recent 35% sell-off. MLT has only 11% of its borrowings exposed to rising
interest rates. Stay invested in hospitality, retail and office REITs as reopening plays.
BUY ART (Target: S$1.31), FCT (Target: S$2.74), FEHT (Target: S$0.77) and LREIT
(Target: S$0.95). Maintain OVERWEIGHT.

WHAT’S NEW

• The Fed’s renewed fervour to clamp down on inflation. The Fed has accelerated the
tempo of interest rate hikes to quell inflationary pressures. It hiked the Fed Funds Rate by
a massive 75bp to 1.50% after the FOMC meeting on 15 Jun 22. Based on the Fed’s dot
plot, the median projected path for Fed Funds Rate would hit 3.4% by end-22 and 3.8%
by end-23. The forecast translates to four hikes totalling 200bp in 2H22, and we expect
another 75bp hike on 27 July. The rate hikes are front-loaded in 2022 and the intensity of
rate hikes could ease after the FOMC meeting on 21 Sep 22.

• Interest rates in Singapore have moved up accordingly. Higher inflation and the
Fed’s intervention have caused short-term interest rates to surge. The US yield curve has
flattened, indicating a slowdown in economic growth. Fortunately, the 10-year – 2-year
term spread has stayed marginally positive at 0.1%. The current short-end of the yield
curve implies forward short-term interest rates at 2.7% for one year, 3.4% for two years
and 3.4% for three years. Three-month SIBOR and three-month compounded SORA
have rose 147bp and 57bp respectively to 1.91% and 0.76% in 1H22. UOB Global
Economics & Markets Research forecasts three-month SIBOR and three-month
compounded SORA to reach 2.75% (+2.31ppt yoy) and 2.29% (+2.10ppt yoy)
respectively by end-22.

ACTION

• Maintain OVERWEIGHT. S-REITs are not out of the woods yet but the gradual easing of
inflationary pressure provides some respite. Real estate is a hedge against inflationary
pressure, which could potentially push rents higher. Downside for the S-REITs sector is
limited to 13.6% if distribution yield yield spikes to 2x SD above long-term mean.

• The good, the bad and the ugly. SASSR has the most conservative aggregate leverage
of 26.2%. Conversely, SUN and MUST are more highly geared with aggregate leverage
of 43.3% and 42.8% respectively. LREIT hedges 90% of its borrowings on fixed rates.
CICT, KORE and MUST also have a high proportion of borrowings on fixed rates of 85%,
84.2% and 86.5% respectively. DCREIT and SUN hedge a lower 50% and 51% of their
borrowings to fixed rates.

• Impact of higher interest rates. We now expect US Fed Funds Rate to hit 3.25% by
end-22 (previous: 2.5%). We have factored in the negative impact on DPU from the
accelerated hikes in interest rates around the globe based on forecasts by UOB Global
Economics & Markets Research. On average, we have adjusted 2023 DPU lower by
2.1% for 20 S-REITs under our coverage.

Digital Core REIT (Upgrade to BUY/DCREIT SP/Target: S$0.98).

• DCREIT has maintained the proportion of borrowings hedged to fixed rates at 50%, which
means the remaining half of its borrowings are exposed to higher US interest rates.

• We expect its cost of debts to increase from the current 2.1% to 3.6% in 2023 assuming
US Fed Funds Rate hit 3.25% by end-22. Capitalisation rates for data centres have
remained compressed and unchanged at about 4% for developed markets. Thus, we did
not factor in any positive impact from the acquisition of data centres. The cut for 2023
DPU forecast is severe at 15% but DCREIT’s unit price has already fallen by 35% from
the peak of US$1.20 in Jan 22 to the current US$0.77. Distribution yield of 5.2% for 2023
is attractive due to its sponsor Digital Realty’s pedigree as the largest data centre
operator in the world and the more limited future supply of data centres.

• Upgrade to BUY. Our target price for DCREIT of US$0.98 is based on DDM (cost of
equity: 6.75%, terminal growth: 2.8%).

Mapletree Logistics Trust (BUY/MLT SP/Target: S$2.08).

• MLT has conservatively hedged 79% of its borrowings to fixed rates. 10% of its
borrowings are unhedged yen-denominated borrowings but JPY Policy Rate is expected
to remain unchanged at -0.1%. This means that only 11% of its borrowings are exposed
to rising interest rates (Singapore dollar: 5% and others (USD, AUD, CNH and INR): 6%).

• MLT has switched emphasis from acquisition to redevelopment projects. It has embarked
on the redevelopment of 51 Benoi Road into a six-storey ramp-up logistics property with
GFA of 865,000sf. It plans to amalgamate and redevelop two newly-acquired parcels of
leasehold industrial properties and its existing Subang 3 and 4 properties at Subang
Jaya, Selangor into a six-storey ramp-up logistics megahub with GFA of 1.4m sf.

• Maintain BUY. Our target price of S$2.08 is based on Dividend Discount Model (cost of
equity: 7.0%, terminal growth: 2.8%).

SECTOR CATALYSTS

• Hospitality, retail and office REITs benefitting from the reopening of the economy.
• Limited new supply for the office, logistics and retail segments in 2022.