Is Ascendas REIT a good defensive stock to hold?

TL;DR

• Ascendas REIT (AREIT) has seen strong operational performance with improving occupancy and growing rents. 
• It has healthy debt levels with a high proportion of its borrowing at hedged to fixed interest rates. 
• AREIT is taking active steps to mitigate the impact of higher electricity prices. There is also a fairly high level of natural hedge for its foreign currency exposure. 
• At its current price of S$2.93, AREIT offers a dividend yield of 5.2%. 

During our recent webinar at SIAS Weekly Update, we were asked about our thoughts on Ascendas REIT (AREIT).

This came after we shared about Keppel DC REIT and Digital Core REIT, which we had written about recently. 

It seems like some REIT investors think that AREIT is the most defensive of the three. 

So let us take a look at whether that’s really the case. 

Before we start, let’s do a short introduction about AREIT for those who might not be familiar with the REIT.

AREIT is Singapore’s first and largest listed business space and industry REIT. Its assets would span three key segments, including (1) business space and life sciences, (2) logistics, and (3) industrial and data centres. 

This might be one of the reasons why investors like to compare AREIT to Keppel DC REIT and Digital Core REIT.

The bulk of AREIT’s assets is in Singapore. It also has properties in other developed markets such as the United States, Australia and UK/Europe. 

What we like about AREIT

#1 – Improving occupancy

AREIT recently reported an increase in the occupancy of its portfolio to 94% in 2Q22 from 92.6% in 1Q22. 

Across geographies, Singapore saw a strong operational performance with occupancy improving to 91.9% from 90.0%. 

Occupancy in the US and UK/Europe also improved. 

The improvements were driven largely by the logistics segments, where demand is growing strongly as increased supply chain disruptions had led to more stockpiling. 

#2 – Strong rental reversions

What was also very positive was that rent reversion accelerated to 13.2% across its portfolio in 2Q22. 

Across all markets, rent reversions grew by double-digits. 

We think that the growth in rental reversions reflects the strong leasing demand that it is seeing for its portfolio. 

In Singapore, the rental index of all Singapore industrial property has risen to 93.7 in 2Q22, compared to just 90.6 in 2Q21.

With the encouraging performance in the first half of the year, management of AREIT has raised its guidance for rental reversions this year to be in the mid-single digit range, compared to its previous guidance of a low-single digit increase. 

#3 – Healthy debt levels

AREIT has a healthy gearing level of 36.7% as of June 2022, slightly higher than 35.9% as of December 2021. 

80% of its debt is hedged to fixed rates, which will help to reduce the impact of higher interest rates. 

As a result, a 1.00 percentage points (or 100bps) increase in interest rates is expected to lead to just a 2.0% reduction in distributions per unit (DPU) according to estimates by AREIT. 

Despite the healthy debt levels, it does not seem like AREIT will be making any significant acquisitions in the near term given the current market volatility. 

What are the risks we’d look out for?

#1 – Higher utilities expense

Despite the higher occupancy and strong rent reversions, AREIT’s net property income (NPI) grew by just 7.0% in 1H22.

This was largely because of the higher utilities expenses for its Singapore properties as electricity prices continue to climb.

However, AREIT is confident that the bulk of the impact from higher electricity prices has already been felt. As such, margins are expected to be stable for the rest of the years.

AREIT is also looking to increase its service charges later this year to offset the higher operating costs. 

It has inked new management agreements that will take effect from October 2022 for the next 10 years, which will result in additional revenue and cost savings.  

#2 – Currency risk from overseas properties

With close to 40% of its assets in overseas markets, AREIT’s distributions could be impacted if these currencies were to weaken significantly against the Singapore dollar. 

This could be partly mitigated, if it is able to borrow in the same currency as the rental income it is receiving. 

At least it wouldn’t have to pay higher interest expense on its debt denominated in other currencies (say the Singapore dollar), which will eat away its rental income in the local currency. 

Here, AREIT has a high natural hedge of about 75% for its overseas property income, where its borrowing is largely in the local currency.  

What would Beansprout do?

In summary, there are a few things to like about AREIT. 

1. It has strong operational performance with improving occupancy and growing rents. 
2. It has healthy debt levels with a high proportion of its borrowing at hedged to fixed interest rates. 

The concerns about the impact of higher electricity costs and foreign currency exposure are definitely valid. 

However, AREIT seems to be taking active steps to mitigate the impact of higher electricity prices. There is also a fairly high level of natural hedge for its foreign currency exposure. 

At its current price of S$2.93, AREIT offers a dividend yield of 5.2% (according to Yahoo Finance) That’s quite similar to the dividend yield of Keppel DC REIT and Digital Core REIT. 

It’s no wonder that many investors consider AREIT to be a defensive REIT to hold on to with the uncertain economic outlook.