Stocks of developers face greater risks than Reits when Sibor spikes: OSK-DMG

RECENT volatilities in local interest rates, resulting in a continual flattening of the yield curve, will benefit more real estate investment trusts (Reits) than developer stocks, OSK-DMG analyst Ong Kian Lin said in a report on Monday.

This is because most Reits have hedged their interest rates (usually pegged to the three-year swap offer rate, or SOR) to fixed rates over the next one to three years.

On the other hand, residential mortgage loans are typically pegged to the three-month Singapore interbank offered rate (Sibor).

The Business Times reported on Monday that the key three-month Sibor has risen almost 60 per cent to 0.64 per cent, from 0.41 per cent barely three months ago last October. But the three-month SOR, the Sibor's more market-oriented cousin, is going the opposite direction.

Mr Ong said that a 50 basis points increase in interest rate will hit Reits' distribution per unit (DPU) by just 1-3 per cent. But "(the Sibor's) recent spike is likely to dampen private home sales even further, posing downside risk to developers," Mr Ong said.

That said, for the first half of 2015, he does not expect a significant downside risk to property prices, especially in the office and retail subsectors.

He also does not expect any major roadblock that may derail the low Singapore 10-year government yields (otherwise known as the risk-free rate), which is already falling below 2 per cent.

Singapore's risk-free rate has fallen another 33.9 basis points week-on-week to 1.81 per cent, while US' risk-free rate is down seven basis points to 1.84 per cent, compared with a year ago.

"Ten-year yields have effectively given back all of their taper tantrum gains and are approaching near-term lows. The unabated drop in oil prices is one of the reasons behind this," he said.

Risk-free rates are used to value Reits; higher risk-free rates tend to pull the fair value prices of Reits lower.

Not too long ago, analysts had said that they favoured developers over Reits, due to developer stocks' low valuations, while Reits face operational pressures, an anticipated rate hike and uncertainty over the impending expiry of certain incentives that they currently enjoy.