- Extended period of high interest rates could result in continued erosion in DPUs till 2024
- Our sensitivity analysis reveals up to a 4% decline in DPUs in a scenario of protracted high interest rates
- Debt-servicing ratio remains stable for most; with selected S-REITs to pursue sales, equity recapitalisation to improve balance sheet flexibility
- Resilience a key trait, prefer retail, industrial S-REITs
Are we ready for an extended period of high interest rates? While we remain constructive on S-REITs as we approach the end of the rate hike cycle, we believe that all are not totally “out of the woods” yet, as near-term funding costs (three-month SORA, 3Y/5Y swap rates) are likely to remain elevated over an extended period before entering a period of normalisation from 2H24 onwards. This means that S-REITs will still feel the erosion of distributions as average portfolio interest rates inch higher in 2024. We have forecasted FY24F DPU growth of 2.0% (-1.0% ex-hospitality), bringing an overall FY24F DPU yield of 6.3% (or a spread of 3.3% against SG 10-year bonds).
Where will it cut the deepest? We have priced in a “through cycle” portfolio debt costs hike of 1.2% in our models and believe this to be sufficient for now. This reflects DBS assumptions of a 100 basis cuts to FED funds rate come 2024. That said, a bear case scenario of a prolonged period of high interest rates till the end of 2024 would potentially drive portfolio debt costs up by another 30 basis points or a c.4.0% cut to our estimates, which we have not priced in for now. This cut would be more keenly felt in the US office, China Retail S-REITs and selected commercial (selected office + retail S-REITs). We expect that the industrial and hotel S-REITs should remain most resilient as they enjoy stronger portfolio cashflows to compensate for the higher interest rates burden.
Debt-servicing ratios are not overly stretched for most. Our analysis reveals that most S-REITs can maintain interest coverage ratios (ICRs) that are >3.0x with the exception of the office and US office S-REITs, given their higher leverage ratios. With little wriggle room, we anticipate that these S-REITs will likely pursue asset sales or selective fundraising to recapitalise their balance sheets.
Positioned in the resilient subsectors. In a slow growth and high interest rate environment, we maintain our conservative stance of preferring the resilient subsectors – industrial (CLAR, MLT) and retail (FCT, LREIT, MPACT). We also like hotel S-REITs (CLAS) for its leverage in the robust medium-term China reopening story.