Winds of change for S-Reits as interest rates normalise (2024)

Derek Tan

Published Mon, Mar 11, 2024 · 6:11 pm

SINGAPORE real estate investment trusts (S-Reits) spent close to two years “fighting the bear”, as Reits share prices remained under pressure on the back of aggressive rate hikes by the US Federal Reserve between late 2022 and 2023.

This is because when interest rates rise, it becomes more expensive for Reits to borrow money to refinance their loans, resulting in an erosion of their dividends.

On top of that, returns from yield products like fixed deposits and government Treasury bills were also on the rise, competing for investors’ capital. That is expected to change in 2024.

S-Reits shine amid rate decline

The Fed signalled a pause towards the end of 2023, and is now expected to deliver rate cuts sometime this year. We see the tide turning, and even brighter days ahead for S-Reits. Since November 2023, S-Reits’ share prices have rebounded off their lows by close to 15 per cent, as concerns over interest rates fade.

While we expect a near-term correction in share prices, we see this as short-lived, as economies are firmly on an interest rate normalisation trend.

We also see room for prices to go higher in the coming months on the back of an expected repositioning among dividend-hungry investors.

S-Reits valuations are still attractive at 0.80 times price-to-book value ratio (P/BV) and widening yield spreads of about four percentage points against the 10-year government bond, which currently stands at 3 per cent.

With rate cuts on the horizon, we believe investors have an opportunity to continue investing into S-Reits as the high estimated dividend yield of close to 7 per cent in 2024 will look increasingly attractive. This is because the sustainability of these dividends will be even more evident when returns from other yield alternatives like T-bills and fixed deposits fall in line with the expected normalisation of interest rates in the medium term.

Interest rates have remained relatively top-of-mind in recent times, but their impact will be less of a concern when rates fall.

Unlocking growth with sustainable dividends

We focus on the sustainability of dividends heading into 2024 and 2025, which are supported by underlying property fundamentals.

The Singapore economy is expected to grow at an improved 2.2 per cent clip in 2024, after a tepid growth of about 0.9 per cent in 2023. The improved economic performance, based on DBS economists’ expectations, is supported by loosening monetary and inflationary conditions. These set the stage for a cyclical rebound in the overall growth outlook for S-Reits.

Still, we believe that investors should consider investing in line with the structural-secular trends of suburban retail, logistics and data centres, where constrained supply conditions support the continued rental and growth in the Reits’ net asset values.

Even though dividend growth prospects have dimmed in recent years due to the impact of higher interest obligations, we see a likely turn sometime in the second half of 2024 to 2025. We attribute this to the current Singapore real estate cycle, which remains landlord-friendly. Most landlords will be able to continue marking rents higher during lease expiries, on the back of resilient occupancy rates.

Our estimates have assumed continued high refinancing rates, with most S-Reit managers maintaining consistent returns. Even then, projected net property income (NPI) growth of about 4.4 per cent over FY24 to FY25 (forecast) will mean that distributions per unit (DPU) will likewise reverse back into a compound annual growth rate of 2 per cent.

Balancing caution with action

With interest rates staying elevated this year, compared to historical ranges, we believe that value ranks higher than safety in the current cycle.

The last data point that restrained investors was the re-pricing of asset values, and we expect that to ease by the first half of 2024.

A sharp rise in interest rates through H2 2022 resulted in a correction in asset prices across most real estate classes, although the impact differed, depending on geography and asset type-mix.

Investors are rightly concerned about the knock-on effects on gearing, but our sensitivity analysis shows that close to 90 per cent of S-Reits are likely to be within the MAS’ lower gearing limit of 45 per cent. This is after the expected reductions in book values, and implies S-Reits’ financial position remains solid. This means concerns around dilutive equity fund raisings to recapitalise balance sheets are likely unfounded.

We are comfortable that, even at our assumed write-offs in asset values, S-Reits are still trading at an attractive P/BV of 0.80 times, close to the minus 1 standard deviation level for most sectors. We believe this is positive; the negatives are likely already priced in at current valuations.

We like industrial S-Reits, which will likely “market perform”. Re-allocations are also expected to feature more heavily in retail, commercial and hospitality S-Reits. We remain firmly vested in multi-year secular trends of logistics and data-centres.

The writer is head of regional property research, DBS Bank