Is the worst over for Singapore Reits?
First-half results of many S-Reits were disappointing; the overall risk-reward proposition remains unattractive
OVER the past year, Singapore Reits (S-Reits) have significantly underperformed the Straits Times Index (STI).
S-Reits recorded a negative total return of -12 per cent during the period, trailing the STI’s positive returns of 2 per cent as at Aug 18, 2023.
The S-Reit earnings season recently concluded. Many S-Reits reported disappointing results for the first half of the year. Only hospitality S-Reits achieved positive distribution per unit (DPU) growth year on year on average, helped by an ongoing travel recovery.
Meanwhile, all other sectors delivered an average growth rate in the negative territory, mainly attributed to higher interest expense due to rising interest rates.
Impact of China’s slowdown
Among hospitality Reits, Far East Hospitality Trust, in particular, posted strong performance with a DPU growth of 24.7 per cent year on year in H1. Driven by healthy tourist arrivals into Singapore and good demand from corporate groups, gross revenue from the hotel and serviced residence segments recovered above pre-Covid levels in 2019.
Looking ahead, a healthy pipeline of events such as the upcoming Formula 1 in September, concerts and receipts from the meetings, incentives, conferences and exhibitions sector are anticipated to continue to attract an influx of tourists to Singapore.
But the next phase of the hospitality recovery largely rests on Chinese tourists, historically the top tourism source for Singapore. Tourist arrivals from China have yet to pick up pace. Indonesian tourists outnumbered Chinese tourists in July, said the Singapore Tourism Board.
In our view, China’s lacklustre economic growth and a weakening RMB against SGD may cause potential Chinese tourists to tighten their belts. Longer-term structural shifts also exist, and the Chinese are beginning to travel more domestically. The Chinese government has supported this shift, rolling out efforts to position Hainan as a top sight-seeing and domestic destination for domestic tourists.
Interest rates a challenge for industrial Reits
Industrial Reits also delivered a relatively resilient performance compared to the overall S-Reit sector.
The largest industrial Reit – CapitaLand Ascendas Reit – achieved improved portfolio occupancy, positive double-digit rental reversions, and contributions from acquisitions. However, DPU still fell by 2 per cent year on year in H1, as the increase in net property income was more than offset by the rise in borrowing costs.
We note that the strong rental reversion was largely led by the Singapore logistics segment. Besides limited supply, third-party logistics companies continue to drive demand for ramp-up logistics assets in the Republic.
Over the long term, we believe that elevated e-commerce penetration and supply-chain diversification should sustain demand and provide resilience for industrial Reits focused on logistics properties. Nonetheless, the high-interest-rate environment remains a key near-term challenge, and several Reits continue to sound caution on higher borrowing costs weighing on DPU growth. While an end to the Fed’s rate-hike cycle may be approaching, we expect policymakers to hold rates higher for longer due to persistent inflation and a stronger-than-expected US economy.
US office S-Reits under pressure
On a less positive note, another sector that caught our attention are the US office S-Reits. The trio of US office S-Reits – Manulife US Reit, Prime US Reit and Keppel Pacific Oak US Reit – reported significant falls in their DPUs in H1. They also saw large share price declines of between 50 per cent and 80 per cent within a year, reflecting the depressed investor sentiment.
Manulife US Reit made headlines when substantial falls in property valuations pushed its aggregate leverage to 56.7 per cent as at Jun 30, way above the regulatory limit of 50 per cent. Moreover, distributions to unitholders were halted for H1, reflecting the immense challenges the Reit is facing.
Looking ahead, we believe the risk of further downward revaluations remains, given elevated office vacancy rates and high interest rates. It may also need to conduct equity fundraising to raise capital and pull its leverage back to a more desirable level. In addition, its bottom line remains challenged by high borrowing costs and a deteriorating US office market.
Meanwhile, its peers also grapple with challenges. At present, Prime US Reit’s leverage is high, at 42.8 per cent. We think that the portfolio valuation could decline further by 10 per cent by end-2023. This would take its leverage to about 47 per cent, just a hair’s breadth below the regulatory limit, providing little buffer against potential changes in market conditions.
Lastly, we think Keppel Pacific Oak US Reit appears to be in a better position to navigate the challenges in the US office market. This is underpinned by its focus on growth markets, which benefit from the migration of businesses drawn by lower taxes and more business-friendly government policies. Furthermore, its leverage stands at a healthy 38.2 per cent, providing greater buffer against a decline in property valuations.
Nonetheless, we are monitoring potential catalysts that could drive a re-rating, such as the stabilisation of the portfolio and better-than-expected earnings in future quarters.
Remain selective
On the whole, the yield spread between the S-Reit sector and the Singapore 10-year government bond remains at a multi-year low, suggesting that the risk-reward proposition is unattractive.
We believe balance sheet strength ought to be a key differentiator when investing in S-Reits, avoiding those with high gearing ratios. Security selection can also be made on a sectoral level.
Amid economic headwinds, S-Reits that benefit from strong secular demand such as industrial Reits should stay relatively resilient. Meanwhile, we reckon investors should avoid buying the dip in US office S-Reits due to a lack of catalysts to drive a robust and sustainable recovery.
Investors who find security selection to be overwhelming may consider a Reit ETF. Viable options include the NikkoAM-StraitsTrading Asia ex-Japan Reit ETF or the Lion-Phillip S-Reit ETF. The latter has no exposure to US office S-Reits.
The writer is an assistant manager with the research and portfolio management team at FSMOne.com, the B2C division of iFast Financial. The latter is a subsidiary of mainboard-listed iFast Corporation
