Shifting interest rate expectations suggest tailwinds for S-Reits

SINGAPORE-LISTED real estate investment trusts (S-Reits) are back on the radar of market watchers after a dismal showing last year. A tapering of aggressive rate hikes should support prices this year, although analysts warn it could still be a bumpy ride ahead for investors in the asset class.

The iEdge S-Reit Index has returned a total of 3 per cent in the year to Mar 23. In comparison, the benchmark Straits Times Index (STI) generated total returns of -0.4 per cent over the same period.

This is a marked difference from last year, when interest rate fears triggered one of the worst sell-offs in the 20-year history of S-Reits. The S-Reits recorded total returns of -11.9 per cent in 2022, whereas the STI had total returns of 8.4 per cent.

The collapse of United States banks such as Silicon Valley Bank and Signature Bank, as well as the troubles of Credit Suisse, have raised anticipation that the US Federal Reserve will ease off its aggressive hiking of interest rates to avoid crashing the economy.

“The recent troubles (in the banking sector) have pushed the Fed into a tough corner, with market expectations that it should turn more cautious on further rate hikes in order to alleviate the balance sheet stress seen in the banking sector due to its aggressive hike stance,” DBS analysts said in a recent report.

A pause on interest rate hikes is seen as good for Reits, which have been grappling with the high cost of debt. Even so, observers say that S-Reits are not yet out of the woods.

Maybank analyst Krishna Guha noted that US two-year and 10-year yields have fallen sharply from recent peaks following the US bank failures.

“A sustained fall in 10-year yields is positive for S-Reits as it results in a lower discount rate in our dividend discount model. Every 50-basis-point fall in the risk-free rate results in 10 per cent higher fair value for the Reits in our model,” Guha said.

But he added: “With tightening financial conditions leading to presumably wider loan spreads and elevated inflation, we maintain our ‘neutral’ sector stance.”

Expect volatility

For now, uncertainty and volatility are likely to give investors reason for pause.

Fluctuations in market sentiment over the US Federal Reserve’s interest rate decisions have already contributed to wide swings in S-Reit prices this year.

The iEdge S-Reit Index raced up 7 per cent in January, before tumbling 3.8 per cent in February. In March, prices of S-Reits slipped another 2.1 per cent.

Gabriel Yap, chairman of investment firm GCP Global, said the price volatility is to be expected: “Like the last interest rate upcycle in 2018, we see that Reits do not go down or up in one straight line.”

The veteran Reit investor noted that S-Reits in 2018 saw price swings of 3 per cent to 15 per cent almost every month, before a recovery of the sector when interest rates stopped rising in 2019.

“We expect such punctuated rallies to persist until we finally see the terminal value or pivot of interest rates for this round,” Yap said, adding that the Fed is very “data-determined”.

Likewise, RHB analyst Vijay Natarajan said rising interest rate volatility, “which is likely to persist in the near term”, would mean S-Reits’ price performance is likely to be “range-bound”.

The brokerage has downgraded the S-Reit sector to “neutral”, from “overweight” previously.

Dark clouds and silver linings

Against this backdrop, independent financial adviser and Reits specialist Kenny Loh said investors would need to be “selective”.

“With the peaking of interest rates or potential pivoting, investors may rotate back to yield assets such as Reits and investment-grade fixed income,” said Loh. “Fundamentally, the current yield and valuation of Reits are relatively attractive. However, not all the Reits are the same.”

Loh favours the industrial sector for stable distributions and the hospitality sector for its growth prospects.

Maybank’s Guha, too, said industrial Reits should “rank favourably among investors in terms of operating metrics and their ability to recycle capital”.

The office segment is seen as less attractive.

“In general, the office and US office segments will be more sensitive to higher interest rates and further downward pressure on portfolio valuations. This is mainly due to their relatively higher gearing as compared to the other sectors,” DBS analysts said.

That could mean this sector has the most room to rebound once interest rates demonstrate a firm shift in trajectory. But analysts aren’t in favour of such risks now.

“We recommend investors stay selective and defensive, rooted on valuations,” said RHB’s Natarajan. “Our preference remains the industrial sector and Reits with strong balance sheets and sponsor support.”

GCP Global’s Yap also said investors should look at a Reit’s sponsor, adding: “Reits are only as good as the sponsors they have.”

He noted that the S-Reits backed by the MACKF sponsors – Mapletree, Ascendas, CapitaLand, Keppel and Frasers – have been among the best picks over the past two decades.