Rising bond yields are triggering a tech sell-off, but S-Reits could be the casualty nobody notices
Singapore-listed Reits have underperformed blue-chip stocks by 29 percentage points so far this year
[SINGAPORE] Wall Street’s latest tech tumble is stealing the headlines again. Semiconductor stocks are taking a dive this week, with bond yields rising and oil prices climbing on renewed Middle East jitters.
The 30-year US Treasury yield on Tuesday (Aug 18) hit its highest level since June 2007, right before the global financial crisis. Meanwhile, 10-year yields are higher than before the first US-Israel strikes on Iran in late February.
Predictably, we are seeing a deluge of commentary about growth stocks and their well-known allergy to higher discount rates. The tech equities wreckage makes for good cinema: fast, brutal and very loud.
But a less cinematic story has been unfolding for months in Shenton Way: the yield-linked decline of Singapore-listed real estate investment trusts (S-Reits).
S-Reits have fallen 7.1 per cent since the start of the year. Over the same stretch, the benchmark Straits Times Index has climbed about 22.1 per cent.
The income darlings, prized by every yield-chasing retail investor, have underperformed the blue-chip stocks by an astounding 29 percentage points.
That gap is massive, but also hardly surprising.
A Reit is essentially a bond wearing a property deed. Investors buy it for the distribution yield, and that yield gets judged constantly against the risk-free rate.
When Treasury yields climb, the spread between what a Reit pays out and what a government bond pays becomes far less flattering. Money drifts back towards the safer asset, and Reit unit prices fall until the yield adjusts back into line.
Then comes the impact on the balance sheet. Reits run on borrowed money by design, and they distribute nearly all their income to unitholders and fund their growth with debt rather than retained cash.
When loans come up for refinancing, these trusts are forced to swallow higher rates. Every extra dollar spent servicing pricier debt comes straight out of the distribution per unit.
For the income investor expecting steady quarterly returns, that translates directly to a shrinking pay cheque.
The yield spread
Analysts use a rough ruler for how much pain a widening gap can cause. A healthy yield spread for S-Reits over the 10-year Singapore government bond sits somewhere between three and four percentage points.
Squeeze that spread too far, and the sector starts to look expensive next to a boring government bond.
This holds true regardless of how solid the underlying mall or data centre might be. A trust can have a long waiting list of high-quality tenants paying premium rents, but if the macro maths is wrong, the unit price will still suffer.
The sharp irony is that Singapore’s own 10-year government bond yield has barely budged. It has sat around 2 per cent for most of this year, heavily anchored by a resilient Singapore dollar.
If an investor were to judge Reits purely on domestic rates, they would be expected to shrug this episode off.
What is actually driving the derating is the US Treasury yield. This is a benchmark with nothing directly to do with Singapore’s own monetary settings. Yet, it still sets the mood for how global capital prices every Reit valuation model across the globe.
But there is some good news locally. The Singapore Overnight Rate Average or Sora, the floating-rate benchmark many S-Reits use to price their debt, has drifted down towards 1.3 per cent as Singapore’s own easing cycle filters through.
Funding costs on new borrowings are actually easing even as unit prices derate. This reads more as a valuation squeeze than a wholesale cash-flow crisis for most domestic trusts.
Still, the current S-Reit derating is deeply unsettling. It has very little to do with anything happening in Singapore. Instead, it has everything to do with what oil prices and Middle East ceasefire talks are doing to bond markets half a world away.
For most S-Reits, the underlying cash flows remain absolutely fine. Suburban malls are packed, and logistics parks are humming. Their unit prices, however, are being marked to somebody else’s geopolitics.
For income investors who bought Reits as the boring, defensive corner of the portfolio, that is the harsh lesson buried in this week’s yield spike.
The tech sell-off got the headlines because it is loud, fast and easy to chart.
Investors, though, should beware: The Reit squeeze is slower and much quieter – but no less deadly.
