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Painting a mixed picture

With the possibility of higher interest rates and the recent spike in 10-year SGS yields, analysts have different views on Reits' outlook

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LOOKING AHEAD: An update by the SGX in mid-May has found that Singapore's 34 Reits and six stapled trusts declined by an average 1.8 per cent in total return.

REAL estate investment trusts (Reits) are a staple in investors’ portfolios, particularly among those in search of stable yields. Based on the FTSE ST Real Estate Investment Trust Index (FSTREI), 2017 was a strong year as the index surged by 28 per cent in total returns. While the backdrop for real estate appears to have turned for the better – thanks to a stronger economy, tighter supply and an uptick in sentiment – Reits performance has been somewhat mixed in the current year.

An update by the SGX in mid-May has found that Singapore’s 34 Reits and six stapled trusts declined by an average 1.8 per cent in total return, bringing the 12-month average return to 9.1 per cent, with an average indicative yield of 6.6 per cent.

According to SGX, since the third quarter of 2009, the FSTREI has on average maintained a month-end yield of 6.3 per cent. This is 4.1 per cent higher than the month-end average of the 10-year Singapore Government Bond yield at 2.2 per cent.

The Reits’ outlook among analysts is mixed, however, citing the likelihood of higher interest rates and the recent spike in 10-year SGS yields. Here is a round-up of analysts’ views.

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Andy Wong, OCBC Investment Research, investment analyst

The S-Reits sector, using the FSTREI as a benchmark, is down by 6 per cent as at May 22. Including dividends, the sector has posted total returns of minus 3.4 per cent. We believe this decline has been driven by concerns over a rising interest rate environment, as government bond yields have seen a spike since the start of the year. The Singapore government 10-year bond yield stood at 2.67 per cent at the close of May 17, a relatively significant increase versus the 2 per cent level at end-2017.

Given that the FSTREI is trading at a forward distribution yield of 6 per cent, this implies that the yield spread against the Singapore government bond yield was 333 basis points. Despite the share price correction year-to-date, valuations remain stretched as this yield spread represents two standard deviations below the five-year average of 410 basis points.

Overall, we are neutral on the S-Reits sector. We believe investors should be selective in this space as sentiment is likely to stay cautious. Our preferred sector picks are Fraser Logistics & Industrial Trust; Fraser Centrepoint Trust; Mapletree Greater China Commercial Trust.

Kum Soek Ching, Credit Suisse, head of Southeast Asia research, private banking research

We estimate an average yield of 5.8 per cent for the S-Reits, which implies a yield spread of 3.2 per cent over the 10-year Singapore government bond yield, compared to an average 3.7 per cent historically. While the absolute valuation for the sector is looking better after the 5 per cent price decline this year, the sector does not look attractive given the compression in yield after the 10-year SGS rose to 2.6 per cent. This would suggest that the market has largely priced in a recovery in the underlying physical market.

The interest rate increase is a well-flagged risk so most Reits have been actively managing their debt exposure and debt expiry schedule. The average gearing for the sector is about 33.4 per cent, a healthy level that leaves some headroom for acquisitions for many of them, and for the larger Reits, fixed rate debt is quite high at between 56 and 85 per cent of total debt, limiting the impact of higher interest rates.

We generally favour retail , industrial and hospitality Reits, but only selectively on valuations in an otherwise expensive sector.

Lee Wen Ching, UBS Global Wealth Management equity strategist

We expect developers to outperform Reits in 2018. Developers are poised to benefit from the improving residential property market, whereas Reits will have to contend with rising interest rates which could dampen their price performance. We are neutral on S-Reits and prefer to adopt a bottom-up approach in stock-picking.

Over the past few years, Reits struggled as oversupply cast downward pressure on rents. We are finally seeing the light at the end of the tunnel for certain sub-sectors. In the hospitality sector the supply of new hotel rooms is declining while demand is picking up, helping to support room rates. In the office space, rents are recovering as demand is stabilising amid scarce new supply. In contrast, retail is still struggling to maintain rents as retailers contend with competition from e-commerce and high occupancy costs. These headwinds could pose risks to the sustainability of distributions.

Derek Tan, DBS Group Research senior vice-president

We believe there are near-term macro-headwinds for S-Reits. This is mainly due to investors trying to price in the impact of four rate hikes (vs three to four of consensus forecasts). Reits are typically sensitive to interest-rate movements in the near term as investors book profits and look to higher returns to compensate for tightening yield spreads brought about by a rise in 10-year bond yields. We see near term pressure on share prices. But we believe that a correction will be short-lived.

In 12 months, we believe that Reits will emerge stronger on the back of a projected recovery in the physical market led by hotels, offices and the industrial segments. This is driven by a fall in supply growth across most sub-segments in 2018-2020. Rental rates are expected to rise on the back of lower supply completions and rental reversions are expected to turn positive and accelerate.

We also believe that Reits will be looking to diversify their earnings base through acquisitions and most will look at overseas opportunities.

Our theme is to stick to growth. We prefer the hotels and office Reits, followed by industrial Reits. Retail Reits are least preferred given their flattish distribution growth profiles. W

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