Investors must brace for more volatility as S-Reits dip to near Covid-19 lows

UNIT prices of Singapore-listed real estate investment trusts (S-Reits) are trading close to their lowest levels in over three years.

The i-Edge S-Reit index closed at 963.91 points last Thursday (Oct 26), down 15.1 per cent for the year to date. It was the lowest close for the index since 2020, when it hit 948.14 on Mar 23 that year, at the bottom of the Covid-19 induced sell-off.

Nearly all S-Reits have also delivered negative total returns over the past month.

The latest sell-off coincides with the US 10-Year Treasury Yield crossing 5 per cent for the first time since 2007, amid expectations that the US Fed will maintain elevated interest rates.

The latest results from S-Reits for the quarter ended September suggest that some of investors’ current bearishness may be justified

Rates and leverage

Around half of the locally-listed Reits and business trusts have released their results or provided business updates in the latest earnings season.

So far, almost all the S-Reits that provided information on distributions have reported weaker distribution per unit (DPU) in the latest period.

Keppel DC Reit’s DPU for its third quarter fell 3.6 per cent on the back of higher finance costs and less favourable foreign exchange hedges.

Frasers Centrepoint Trust’s (FCT) DPU for its second half fell 1.2 per cent, as finance costs jumped 71.3 per cent on year. The manager noted that interest rate movements and rising operating expenses will remain key factors in affecting performance.

Suntec Reit’s Q3 DPU fell 14 per cent. The manager noted that the results were mainly hit by higher rates, and added that a prolonged period of elevated rates is likely to keep DPU muted compared to 2022 levels.

Hospitality Reits were among the minority that achieved better distributions.

Far East Hospitality Trust reported a 51 per cent increase in distributable income for Q3, amid the recovery in tourism.

As debt in their capital structure naturally translates to higher finance costs, the effects of high interest rates on S-Reits is not unexpected.

Unit prices have seen volatile trading since the US Federal Reserve began hiking rates in March 2022, as investors weighed the eventual impact on Reits.

While some of the impact is now visible in the form of lower distributions, the worst may not be over yet.

While most of the Reits employ some level of hedging to fixed rates, many have guided for their total cost of debt to rise further next year, which would weigh on distributions.

Besides the impact of higher finance costs, another concern for investors is whether Reits’ operations can continue to hold up in a more challenging macroeconomic environment.

The news is slightly more positive in this regard.

Operational performance

Of the S-Reits that have announced their latest results, over three-quarters have reported higher gross revenue and net property income (NPI).

Managers have also reported stable occupancy and positive rental reversions across most of their portfolios.

However, it remains to be seen whether such performance can be sustained in the coming quarters.

Reit managers in certain sectors such as hospitality remain relatively optimistic, as they expect a continued recovery of tourism. But other managers have expressed a more cautious outlook.

Suntec Reit’s manager, for example, warned of softer office demand with rent growth slowing, even though it still expects rental reversion to be positive.

The manager of CapitaLand Ascendas Reit also noted that high interest rates, inflation and global economic uncertainties continue to pose challenges. It added that these may have an impact on tenants’ businesses as well as on the Reit’s operating costs.

Mapletree Industrial Trust’s manager said that rising property operating expenses and increases in borrowing costs could continue to exert pressure on distributions. But the manager will adopt cost-mitigating measures while focusing on tenant retention to maintain a stable portfolio occupancy level.

Staying selective

Reits’ distributions have already been hit by the sharp increase in borrowing costs. The sector could face a double whammy if more challenging macroeconomic conditions globally also result in weaker operating performance in future.

The asset class is also facing competition from other instruments, as conservative investors can currently get decent returns from risk-free instruments such as Singapore Savings Bonds and Treasury Bills.

While the mood in the sector is rather bearish at the moment, the lower entry prices now could tempt bargain hunters.

The sector currently has a median trailing distribution yield of around 8.3 per cent, which is still a good premium over risk-free rates.

DBS analysts also said in an October note that it is “too late to turn bearish” as markets approach or are past the peak period of interest rate hikes.

But the worst may not be over for the sector, and it would be crucial for investors to be selective and choose only Reits that are likely to face fewer issues in the coming months.

Reits that are lowly geared, or those that have more of their debt hedged to fixed rates, would likely suffer less. Meanwhile, Reits that are in sectors that are less affected by the economic cycle may also prove to be more resilient.

In the short to medium term, more volatility is likely, given the uncertainty over the trajectory of interest rates.

But opportunistic investors may find the current lows in the market to be an attractive entry point, if their view is that interest rates will return to more palatable levels before long.