Reits could offer investors shelter amid inflation storm

Singapore

THE scourge of inflation is rattling equity markets with most pundits expecting rising prices to peak in the second quarter. Amid the headwinds, real estate investment trusts (Reits) could provide a safe harbour for investors, say analysts.

"Inflation is climbing, driven by both cyclical and structural factors, and will likely peak in Q2 before moderating in the second half. Inflation pressures from energy and food prices, and supply chain disruptions, will likely ease by the second half of 2022," said Maybank Investment Banking Group analysts Chua Hak Bin and Lee Ju Ye in a recent report.

One of the key concerns in the minds of investors is the rising risk of stagflation - stagnant growth with high inflation - that have proved to be tumultuous periods for financial markets.

"Today, this concern has arisen because inflation again reared its ugly head," said DBS chief investment officer Hou Wey Fook at a recent webinar.

"Our baseline view is that inflation will stay elevated for a while longer, although over time we should see it coming off as supply chains normalise."

Hou further noted that past performance suggests Reits do not suffer as badly from inflation and interest rate hikes.

"Reits own and rent out real physical assets such as commercial, retail and industrial buildings like warehouses and data centres. So when inflation is running higher, rentals would keep in step," he said. "Potentially, the value of the assets, the cost of the building, will also go up."

MFS Investment Management global investment strategist Robert Almeida and research analyst Matthew Doherty describe Reits as a "hybrid" asset class that sit somewhere between equities and bonds.

"They're viewed by investors as equities due to their potential for real capital growth, but also as bonds because of their income streams and focus on consistent capital return through dividend income. As a result, inflation matters in this asset class," they said.

In a study of periods of rising core inflation dating as far back as the 1970s, Almeida and Doherty found that Reit performance during inflationary periods have been mixed.

"As a general rule, Reits with shorter leases offer greater inflation protection than those with longer ones," they said. "Conversely, long-lease subcategories such as grocery, freestanding retail and office landlords are more at risk."

For this reason, industry watchers advocate a barbell approach to investing in Reits.

While the protracted recovery of international travel as well as a tapering of government and staycation demand is expected to weigh on hospitality Reits, Jefferies analyst Krishna Guha sees potential for those in the commercial and industrial sectors.

"Singapore-listed real estate investment trusts (S-Reits) may offer stability amid volatility," he said. "Commercial Reits will benefit from progressive reopening, domestic demand resulting from higher wages and measures such as the introduction of e-commerce taxes. Simultaneously, industrial Reits will benefit from structural demand for new economy assets as well as shifts in supply chains."

Guha added that some of the S-Reits may also be able to mitigate the impact of inflation through support from sponsors, diversification of revenue sources and pivot to new assets. "S-Reits will continue to provide steady yield and modest growth," he said.

For now, however, uncertainty over the timing and pace of US Federal Reserve interest rate hikes this year is expected to have a drag on S-Reits' prices in the first half of 2022.

"As the outlook remains unclear in the immediate term, we believe that investors should stay vested alongside selected 'domestic reopening' plays and S-Reits with a 'new economy' focus for their stronger growth profiles," said DBS analysts Derek Tan, Rachel Tan, Dale Lai and Geraldine Wong in a recent report.

"US Federal Reserve normalisation and rate hikes are a possible headwind but S-Reits' wider-than-average spreads imply that returns can remain positive," they added.