Summary: After strong gains in March when Singapore started to reopen domestically, Singapore REITs (S-REITs) have seen a slide into May due to the concerns around rising interest rates. Singapore stands to benefit from the global and regional reopening, and REITs with a manageable debt profile and a solid distribution history stand to benefit from this trend.
Singapore REITs have underperformed recently. The FTSE ST Real Estate Investment Trusts Index (FSTREI) is now down over 4% since the start of the year, compared to STI’s gain of 3.6%. This is partially due to the rise in inflation which could potentially lower distributions, but also due to the increases in interest rates as that has a material impact on REITs’ finance costs especially if they carry a large floating rate debt. General risk-off sentiment and the flight to safety has also diverted most investments to safer asset classes, primarily cash/US dollar. Still, Singapore REITs have outperformed the global REITs portfolio this year
Asia’s reopening to boost interest in S-REITs. The reopening theme is playing out well in Asia with most countries now allowing international travellers with reduced testing requirements. Singapore especially stands to benefit from this trend as it was one of the first movers in the reopening space and is a preferred tourist destination. This has boosted rental incomes especially for retail and office spaces, and property values are also holding up. Hospitality sector is a key beneficiary as well with room rents increasing.
Strong financials provide buffer against higher inflation and interest rates. A modestly higher inflation is good for the REITs sector, as it also means higher rents. Persistently higher inflation, on the other hand, can mean higher utility costs for REITs that may weigh on distributions. Some of these higher costs may be defrayed through higher rents and service charges, but REITs still need to bear a part of these. If interest rates rise as well, this will also mean higher interest liabilities for the REITs. But most REITs have a strong dividend yield (5-year average of ~5%), which is the most attractive to those seeking an income solution especially when compared to government bond yields of 2.6% and fixed deposit rates of 1%. Generally speaking, a rising interest rate environment signals strong economic growth and higher inflation – both of which are key reasons to stay invested in the real estate sector. Still, it is wise to consider REITs that have a strong distribution history, as well as ensure diversification in your portfolio.
One key area of concern is the level of floating debt that a REIT holds – given that higher floating debt could mean a higher interest burden as interest rates rise, resulting in lower distributions. Suntec REIT has higher exposure to rising interest rates than most peers with aggregate leverage ratio of 43.7% (MAS mandate is a limit of 50%) at the end of last year and fixed rate borrowings of 53%. Keppel REIT is also exposed with aggregate leverage of 39% and fixed rate borrowings of 71% as of March 2022. By comparison, Capitaland Integrated Commercial Trust (CICT) has aggregate leverage of 39% with 85% of the borrowings in fixed rate as of March. This means Suntec REIT is more likely to cut distributions if interest rates rise substantially as compared to CICT which has a more sustainable debt portfolio.
Office and Retail REITs offer value proposition. With the broad reopening theme playing out, we see bright spots in office and retail REITs in Singapore. Most employees are heading back to work now, although companies still seem to be offering flexibility. With supply remaining restrained, there is potential for office REITs like CICT, Mapletree Commercial Trust and Suntec REIT to increase rents. Shopping activities are also moving increasingly offline, and retail spaces have become attractive again as well which may benefit retail REITs like Frasers Centrepoint Trust. We also expect the reopening benefits to flow to hospitality REITs such as Ascott Residence Trust and CDL Hospitality Trusts. Lastly, high growth industrial REITs delivered the highest returns in 2021 as new economy assets like data centres gained interest, and demand for logistics spaces is likely to remain high his year as well. Singapore REITs offer diversification benefits not just across industrial, hospitality, retail, office, and healthcare sectors, but also geographically with most owning real estate properties across the world. Investors can also look at ETFs in this space, such as Lion-Phillip S-REIT ETF (SREITS) and NikkoAM-StraitsTrading Asia ex Japan REIT ETF (AXJREIT) for a more diversified exposure to Singapore REITs. Key risk to watch will be inflation worsening rapidly, resulting in a sharp increase in interest rates.
Source: Bloomberg, Company reports, Saxo Markets
Source: Saxo Bank
