S-Reits poised for rerating despite hawkish Fed backdrop: DBS

[SINGAPORE] Real estate investment trusts (Reits) in Singapore, Hong Kong and Thailand have shown resilience despite a more hawkish market backdrop, DBS Group Research said.

The negatives have already been priced in, although the impact is differentiated among the three markets, the research house noted in a Monday (Jul 6) report.

Investors across the region have sought shelter in defensive Reits amid global economic uncertainty, keeping Reit valuations “attractive”. This should “cushion near-term volatility in the interest rate trajectory”, with yields ranging from 4.9 to 7.6 per cent helping to drive inflows back into the sector, DBS said.

That volatility stems from the US Federal Reserve, which left its rate unchanged at 3.5 to 3.75 per cent in June. At the same time, it delivered a “notably more hawkish message” by reiterating its commitment to restoring price stability, offering less forward guidance and removing its previous easing bias, observed DBS’ analysts.

Against this backdrop, DBS expects the upcoming earnings season to serve as a catalyst for Singapore-listed Reits (S-Reits), with results likely to drive a further rerating in the sector’s valuations despite its lacklustre performance so far this year.

Singapore, Thailand Reits relatively stable

While the Fed’s hawkish stance weighed on regional real estate markets in June, performance was mixed.

DBS’ analysts noted that when global interest rates and bond yields rise, income-seeking investors rotate out of Reits and into safer government bonds, driving Reit unit prices down.

Most Asian bond yields have indeed risen and are now about 40 to 50 basis points off year-lows. Singapore, however, is an exception, with its 10-year yield anchored around the 2.04 per cent level.

Because Singapore’s risk-free rate did not spike, S-Reits remained relatively stable, rising 0.4 per cent month-on-month. Thai Reits rose 3.1 per cent, while Hong Kong Reits fell 5.4 per cent.

“We remain comfortable that S-Reits remain relatively well-positioned given easing domestic funding costs, resilient occupancies and healthy rental reversions,” DBS stated.

It added that capital recycling and asset optimisation continue to support earnings. S-Reits currently offer yields of 6.2 per cent, compared to 7.8 per cent for Hong Kong and a range of 4.9 to 7.6 per cent for Thailand.

“Yield spreads have also expanded above historical averages, giving support to share prices,” the note said.

The differentiated impact comes as Hong Kong Reits continue to face a more challenging backdrop. Elevated interest rates coincide with soft office leasing demand, high vacancy rates and subdued investment activity.

Still, a lower Hong Kong Interbank Offered Rate, which is the benchmark borrowing rate for Hong Kong banks, and ongoing policy support should provide some relief to funding costs.

Meanwhile, Thai Reits have been comparatively more resilient, supported by a recovery in tourism, improving retail spending and hospitality demand. Nevertheless, sentiment remains sensitive to global interest rates given foreign investor participation and the sector’s reliance on external capital markets.

“We remain selective, favouring Reit platforms with strong balance sheets, limited refinancing risk, visible rental growth and active capital recycling,” DBS said, noting that such Reits should “outperform as funding conditions gradually stabilise”.

What to look out for

S-Reits have underperformed in the year to date as investors rotated towards growth and cyclical stocks. The FTSE ST Reit Index rose 0.4 per cent month-on-month in June, but underperformed the 2.6 per cent rise in the Straits Times Index (STI).

This divergence has been evident since the start of the year, with the Reit sector declining 6.1 per cent while the STI rose 11 per cent.

The upcoming results season will likely drive further rerating, said DBS. Because this is a dividend-paying quarter for several S-Reit, investors will closely examine the sector to gauge the overall distribution trajectory for the year.

S-Reits’ operating metrics remain stable, and interest rates have stayed low compared to three or four years ago. As a result, current Singapore benchmark interest rates are still “substantially below” the S-Reit sector’s average borrowing cost of above 3 per cent.

This preserves scope for further debt repricing benefits as legacy borrowings mature and are refinanced, said DBS.

“We maintain our view that selected S-Reits, especially those with a larger proportion of Singapore-focused exposure to still see savings at refinancing,” it noted, adding that this will boost distributions higher.

Valuations also “remain attractive despite higher-for-longer yield concerns”, as the market has already priced in a substantial portion of the risk.

Forward full-year yields sit at about 6.2 per cent, with a yield spread of 4.2 per cent. DBS noted these are close to one standard deviation below its long-term average, which provides “support to the sector”.