Brokers' take: S-Reits can weather rising inflation to gain returns, says OCBC

SINGAPORE-LISTED real estate investment trusts (S-Reits) should be able to mitigate rising inflation, despite higher inflationary pressure possibly impacting margins in the sector, said OCBC Investment Research on Tuesday (Mar 1).

In a research note, the brokerage highlighted some tactics S-Reits can employ to alleviate inflation concerns, which include engaging in bulk purchase of electricity, passing through higher utility costs to tenants as higher service charges and using automation technology to reduce manpower costs.

It also said that S-Reits can consider lease structures that have annual rental escalations or periodic market rent reviews, as well as direct indexation that is linked to the consumer price index (CPI), to help weather rising inflation.

This was based on its findings that there was a meaningful positive correlation between the year-on-year change in Singapore's CPI and year-on-year changes in both the Singapore property price and rental indices, from 2005 to 2021.

In particular, the residential and industrial sub-sectors have the highest correlation between CPI changes and each sub-sectors' capital values and rents, while retail has the lowest, noted OCBC.

Additionally, it believes that S-Reits under its coverage have been prudent in their capital management and should continue doing so to mitigate increasing interest rates, which are poised to climb as major central banks are likely to raise benchmark rates in 2022.

"The average gearing ratio stood at 37.4 per cent, as at Dec 31, 2021, while 74.4 per cent of their borrowings are fixed or hedged, which would mitigate the expected increase in borrowing costs ahead," said the brokerage.

Its positive outlook was also backed by historical data, as during the major hike cycles from 2004-2006 and 2015-2018, the S-Reits sector delivered positive share price return from the start of the first hike to the start of the first rate cut, although there was some volatility in 2018.

OCBC therefore continues to recommend a barbell strategy in terms of sector positioning, focusing on the higher quality large cap names with strong sponsor support amid an uncertain macroeconomic and geopolitical environment.

Its preferred picks among S-Reits with reopening and recovery plays are Ascott Residence Trust HMN and CapitaLand Integrated Commercial Trust C38U .

It also likes Ascendas Reit A17U, Frasers Logistics & Commercial Trust BUOU and Mapletree Industrial Trust ME8U for their exposure to new economy assets, which the brokerage believes are more resilient and defensive over the longer run.

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