• S-REITs Index fell 6.9% MoM in October, due to the hawkish stance of FOMC to hold interest rates higher for longer. 3Q23 results were mostly in line with our expectations, as all REITs were negatively impacted by higher interest rates.
• S-REITs are now trading at a forward dividend yield of c.6.9%, 1.3x s.d. above the mean of 6.1% and a P/NAV of 0.8x, 2.6x s.d. below the mean of 1.03x. We think this is an opportune time to reposition into S-REITs for the eventual interest rate pause and decline.
• We remain OVERWEIGHT on S-REITs but are more selective. We prefer REITs with a healthy balance sheet, strong sponsor and improving operating metrics such as the hospitality and retail sub-sector. Catalysts are expected from a pick-up in the economy and asset recycling. Top picks are CapitaLand Ascott Trust (CLAS SP, BUY, TP S$1.04) and Frasers Centrepoint Trust (FCT SP, ACCUMULATE, TP S$2.29).

SECTOR ROUND-UP

The FOMC held the federal funds rate unchanged at 5.25-5.5% on 1 Nov 23 and stated that it would be appropriate to keep its restrictive stance for some time until inflation is clearly moving down sustainably to its 2% target. This higher for longer stance on interest rates impacted the sentiment of S-REITs as seen from its 6.9% MoM decline.

3Q23 S-REITs results under our coverage were in line with our expectations. Since most REITs release audited financial statements only bi-annually, minimal financial data were provided in the 3Q23 business updates. All S-REITs were affected by higher interest expenses, resulting in a negative impact on distributable income. Excluding the hospitality sub-sector, where improvements in revenue more than offset any rise in interest expenses, the 6-month DPU was down c.3.5% YoY on average for REITs that released financials this past quarter. In some cases, however, past divestment gains were used to top up DPU to offset the impact of higher interest rates. Some examples of this were Mapletree Logistics Trust (MLT SP, non-rated) and Mapletree Industrial Trust (MINT SP, non-rated).

Retail

Sep 23 retail sales index (excluding motor vehicles) grew 0.5% YoY but softened from the 4% growth in Aug 23. It is now at 16.6% above Sep 19 pre-COVID levels. The F&B services index grew 6.9% YoY in Sep 23 with food caterers (+24%) experiencing the largest growth due to increased gatherings. The strong retail sales supported mall owners’ ability to raise rents, and this could be seen from Frasers Centrepoint Trust’s and CapitaLand Integrated Commercial Trust’s (CICT SP, non-rated) positive rental reversions from its retail portfolio of 4.7% and 7.8% respectively, for FY23. Furthermore, FCT’s FY23 portfolio valuation for its retail portfolio increased 0.6% YoY with unchanged cap rates, suggesting that suburban retail malls in Singapore continue to exhibit resilience despite rising interest rates.

Hospitality

Singapore’s international visitor arrivals grew 38% YoY in Oct 23 to 1.13mn, and it is still at 26% below pre-COVID Oct 19. RevPAR grew 14% YoY in Sep 23 to S$269 on the back of higher room rates. For stocks under our coverage, CLAS reported a 17% growth in 3Q23 RevPAU YoY and it has reached 102% of pre-COVID 3Q19 levels. All markets experienced RevPAU growth YoY, with Singapore, Australia, USA, UK and Japan performing above 3Q19 levels — indicating a strong recovery post-pandemic.

Office

Singapore average core CBD grade A office rents continued to increase marginally to $11.85 psf pm in 3Q23 from $11.80 psf pm in the previous quarter. Core CBD occupancy also ticked up QoQ to 95.3% in 3Q23.

The US office sector continues to face headwinds, with higher vacancies and further valuation declines expected at year-end. Prime US REIT’s (PRIME SP, BUY, TP US$0.37) occupancy is now at 85% with headline rental reversions at -2% for 3Q23. Prime will focus on net effective rents with lower capex requirements in this challenging US office environment.

Industrial

Logistics assets continue to outperform in this sub-sector with the continued growth of e-commerce and supply chain demand. ESR-LOGOS REIT (EREIT SP, non-rated) indicated that demand is coming from pharmaceutical companies with cold storage requirements as well as life sciences. Furthermore, some logistics properties were even bought over by end-users who use it for themselves.

However, China remains weak, especially in Tier-2 cities, as the consolidation among e-commerce providers negatively impacts demand. This is evident from MLT’s negative rental reversions of 8.6% in China for the previous quarter.

INVESTMENT RECOMMENDATION

OVERWEIGHT on SREITs (Maintained)

With the share price correction following the recent FOMC meeting, S-REITs are now trading at a forward dividend yield of c.6.9%, 1.3x s.d. above the mean of 6.1% (Figure 4) and a P/NAV of 0.8x, 2.6x s.d. below the mean of 1.03x (Figure 3). We think this is an opportune time for investors to reposition into SREITs for the eventual interest rate pause and decline. However, we think it will remain challenging for S-REITs (apart from the hospitality sub-sector) to grow DPU with higher borrowing costs and forex headwinds expected.

Bloomberg consensus forecasts 2023/24 SG10Y yields at 2.97% and 2.83%, respectively. The dividend yield spread at 3.5% is 0.7x s.d. below the mean of 4% (Figure 2), improving from 3% MoM. We expect the yield spread to continue to widen as the SG10Y yield starts to soften.

Sub-sector preferences: Hospitality and Retail (Unchanged)

We think the hospitality sub-sector will be able to generate the most DPU growth on the back of higher RevPAR and the gradual reopening of China as outbound flight capacity from China increases. Suburban retail offers resilience in a downturn while downtown retail stands to benefit from the recovery of international visitor arrivals, which will in turn lift tenant sales and sentiment.

Retail (OVERWEIGHT). With tenant sales still growing YoY and higher than pre-COVID levels, we believe the potential for positive rental reversions is still intact for both downtown and suburban malls. Downtown malls benefit the most from reopening as international visitor arrivals pick up, while suburban malls which focus on essential services remain resilient in a slowdown. There is also very little new supply hitting the market. Return to office and a pick-up in major events to be held in Singapore in 2024 should continue to lift tenant sales and give confidence to retailers.

Office (NEUTRAL). We think core CBD Grade A office rents at $11.85 psf pm in 3Q23 will come under pressure as the market absorbs more supply coming in 2024 from IOI Central Boulevard Towers (1.2mn sq ft) and Keppel South Central (600k sq ft). More downsizing could occur as companies reassess their office space needs from hybrid work arrangements. We expect further declines in US office property valuations, due to cap rate expansion and weaker operating performance.

Industrial (NEUTRAL). The slowdown in manufacturing will likely affect industrial property demand. However, industrial REITs are benefiting from the secular growth of new economy tenants such as tech, life sciences, biomedical, semi-con and electronics manufacturing, which typically locate themselves in high-spec, science and business parks and warehouses. Logistics demand remains strong with demand coming from many third-party logistics businesses.

Source: Phillip Capital Research - 27 Nov 2023