Outlook for REITs in 2H2019

Ms Tara Wong, Research Analyst of PhillipCapital

The S-REITs have had a good start to the year to date, clocking in a +10% total return, propped up largely by gains recorded by the Commercial and Hospitality subsectors. On the macroeconomic front however, the sector yield spread – which is the difference between the S-REIT dividend yield and the benchmark 10-year SGS (10YSGS) yield – has been looking less-than-sanguine lately, recently dipping further below the post-global financial crisis (post-2010) -1 standard deviation (s.d.) at 261 bps.

While this decline in yield spread mirrors the decline in S-REIT dividend yield itself during the same period, the rise of the 10YSGS during this same period has further eroded the yield spread. All things unchanged, this is expected to continue to be the case with the Bloomberg consensus forecast for the 10YSGS at end-2019 and end-2020 at 2.50% and 2.44% respectively. The current 10YSGS is at 2.26%. On the short end of things, higher interest rates would also feed into the finance costs, which is the single biggest cost component at c.15-20% of net property income.

REIT managers thus have to work harder to churn out a Distribution per Unit (DPU) level that will make it worth investors’ while. In short, they have to grow their DPU faster than the rise in interest rates. Besides proactive capital management, operational metrics would also have to be managed well to counter any sub-sector headwinds.

Going into sub-sector specifics in Singapore, the current outlook for commercial and hospitality sub-sectors appears to be the most positive but less so for the retail and industrial sub-sectors.

Based on latest quarterly data available, central office rents continued its upward trajectory to end the year at 181.4 pts (+13.3pts YoY) in 4QCY18. Office REITs currently hold an above 98% occupancy, well above the average central office occupancy of 94.8%. Demand is still coming on strong from the banking and financial services, business consultancy and real estate and property services segments, as well as the co-working space segment.

Average RevPAR (revenue per average room), computed as multiplication of average daily rate and occupancy rate, rose 3.5% YoY in 2018, reversing the negative YoY growth recorded in the past five years (save for 2014: +0.3%). This rise in RevPAR is expected to be supported by favourable supply conditions, with the new supply of hotel rooms tailing off.

For retail, the outlook is neutral as weak tenant sales growth still continues to compress rental reversions. In addition, net supply through 2019 and 2020 is still above the 5-year historical net annual demand, which could weigh on landlords’ rents. We also adopt the same neutral outlook on industrial though the reason can be attributed more towards the tepid industrial activity than the supply conditions.

While we adopt a neutral stance on a macroeconomic front, we remain selective on our sub-sector preferences for the commercial and hospitality sub-sectors. Further, taking a look at the idiosyncratic factors – each REIT’s capital management status and track record such as the gearing level, percentage of debt hedged on fixed rates and level of debt due in the near-term (next two years) – should aid investors especially in a rising interest rates environment.

Since 1975, the PhillipCapital network has grown into an integrated Asian financial house with a global presence that offers a full range of quality and innovative services to retail and high net worth individuals, family offices, corporate and institutional customers.

Our comprehensive suite of financial products and services includes broking in securities, futures, foreign exchange, bonds, precious metals and commodities, unit trusts, contracts for difference, exchange traded funds; fund management, managed accounts, insurance planning, regular savings plans, investment research, equity financing and property consultancy. Institutions can also benefit from our corporate finance and advisory services as well as information technology solutions.

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