S-Reits to hit ‘turning point’ in coming quarter amid expectations of interest rate cuts

AFTER two years of declining share price performance, analysts believe that Singapore-listed real estate investment trusts (S-Reits) will hit a “turning point” in the coming quarter amid expectations of an interest rate cut by the US Federal Reserve this September.

However, S-Reits are likely to report lower year-on-year distributions in the upcoming earnings season as they continue to refinance maturing low cost of debt, said analysts.

And while United States president Joe Biden’s exit from the presidential election race on Monday (Jul 22) would not have a short-term impact on interest rate cuts, a Trump presidency – which seems increasingly likely – could spell trouble for S-Reits in the longer term, added analysts.

Their comments come ahead of the upcoming results season, which kicks off on Tuesday.

Most S-Reits will be reporting their financial results for the first half of FY2024, while Reits sponsored by Mapletree and Frasers Property will be issuing their Q1 and Q3 results, respectively.

Analysts that The Business Times spoke to were optimistic that the performance of Reits would improve after their relative underperformance over the last few years due to higher-for-longer interest rates.

The iEdge S-Reit Index has fallen by about 20 per cent over the last two years.

Carmen Lee, the head of OCBC investment research, said that while there is still some cautiousness among investors towards the Reit sector, there were nevertheless “comforting” data points to suggest that Reits’ performance would improve going forward.

These include occupancy rates, which are above 90 per cent for many Reits, as well as rental renewals which saw some Reits increase their rents by 3 to 5 per cent.

“I feel almost certain that it has bottomed out,” said Lee, during a media briefing last week on the outlook for S-Reits in the second half of this year.

Similarly, Xavier Lee, an equity analyst for Morningstar, noted that Reits have underperformed due to concerns of interest rates staying higher for longer.

“With our economist expecting a first rate cut in September, we think this marks a potential turning point in investors’ sentiment and interest towards Reits,” he said.

Darren Chan, a senior research analyst at Phillip Securities Research, added that he does not expect Biden’s decision to drop out of the presidential re-election race to have a significant bearing on interest rates as they are driven primarily by economic factors and decisions by the Fed, which is an independent government agency.

However, if former president Donald Trump wins the US elections in November this year, S-Reits may see downside risks, particularly those with exposure to China or the foreign exchange market (FX), said Maybank analyst Thilan Wickramasinghe in a note on Jul 9.

The sector may see increased volatility amid increased regional macro and FX uncertainties if the Trump administration escalates tensions with China. S-Reits with exposure to China and Vietnam – which has a widening trade surplus with the US and growing China foreign direct investment – could see an impact to their operations, he added.

Wickramasinghe noted that Mapletree Logistics Trust and Mapletree Pan Asia Commercial Trust derive around 30 per cent of their revenue from greater China.

Lower distributions

Lee of Morningstar said that Reits’ cost of debt will continue to inch up in the next quarter as they refinance their maturing debt. “This should put pressure on distribution per unit (DPU) growth,” he said.

Similarly, Maybank analyst Krishna Guha expects the DPU of Reits which are reporting their full financial statement results to be lower on a year-on-year basis.

However, Reits in the hospitality sector would be an exception, he said. Guha expects Reits in this sector to post higher year-on-year distributions due to a low base effect.

He is also expecting the DPU of CapitaLand Integrated Commercial Trust and Keppel Reit to be supported by operation and divestment gains.

The strong Singapore dollar will also impact income received in foreign currencies, said Phillip’s Chan.

Office Reits

Across the various sectors, analysts said they will be watching out for the performance of office Reits, whose valuations have been lagging compared with their counterparts. 

Lee of Morningstar said that he expects Singapore office rents to remain flat in the second half of 2024 as the weak demand for office space is offset by relatively low supply.

Maybank’s Guha said that he is expecting Singapore office Reits, as well as industrial and suburban retail Reits, to perform relatively better than overseas office and hospitality Reits.

He noted that data points for Australian and United Kingdom offices suggest that overseas offices will not perform as well. Australian offices have seen their valuations and operations deteriorate for the second quarter, while offices outside the UK’s city-centre prime area are not performing as well as their city-centre counterparts.

Meanwhile, Phillip’s Chan said that he is monitoring the US office Reits sector for potential recovery in occupancy and transaction volumes, as well as progress on deleveraging.

US office Reits have been hit hard by changing work patterns and a higher interest rate environment.

The trio of US office Reits listed in Singapore – Manulife US Reit , Prime US Reit , and Keppel Pacific Oak US Reit (Kore) – were the worst performers in the benchmark iEdge S-Reit Index in 2023.

Retail Reits

Guha of Maybank noted that visitor arrivals to Singapore for the second quarter have weakened. This will likely have an impact on retail Reits in the downtown area, he added.

However, Lee felt that lower visitor arrivals will not have a major impact on retail rental growth, as it is supported by healthy occupier demand and low retail supply. Likewise, Phillip’s Chan said that he expects the retail Reit sub-sector to perform better from higher positive rental reversions.

The reporting season will kick off with Sabana Industrial Reit reporting its H1 business update after the close of markets on Tuesday. This will be followed by Digital Core Reit on Jul 24.

Other Reits reporting their earnings this week include CapitaLand Ascott Trust and Suntec Reit . More counters will release their results the following week, including CDL Hospitality Trusts on Jul 30, Frasers Logistics and Commercial Trust on Jul 31 and Manulife US Reit on Aug 5.