Is the worst over for Singapore REITs?

Summary

• Prices of REITs are bouncing back from the lows on rising confidence of a first rate cut by the Fed in September this year. The grounds for the optimism are that lower interest rates could lift distributable income and asset value, and rejuvenate M&A activities. If rate cut were to take place from 4Q24, the benefit is likely to flow through only from 2H25, in our view.
• We expect borrowing costs to fall only from FY25E. Any adjustments to the borrowing costs are likely to be felt earliest in FY25E, as the majority of the REITS have more than 60% of debt on fixed rates. Effective interest rates are still expected to rise through 2024. We estimate a 0.2% to 1%-point increase in average cost of borrowings across the REITs, due to debt refinancing or roll-off of interest-rate hedges. 
• Strong S$ will impact distributable income and book value in FY24E. Year-to-date, S$ has strengthened against regional currencies, including Yen (+10.2%) and RMB (+0.7%). It is only weaker against Pound Sterling (-5.0%), US$ (-2.6%) and HK$ (-1.7%), and flat against Euro, A$ and Ringgit. REITs with overseas assets are likely to report lower 1H24 DPU. This would also affect translated book value.
• We believe REITs with Singapore office assets are likely to fare better in preserving DPU and asset value. Weaker consumer spending is likely to affect the retail and hospitality REITs. Industrial REITs could face concerns on rising supply. We would avoid the REITs with China retail assets, and the US office REITs are still not out of the woods.

Singapore REITs have rebounded from lows

Softer US inflation and jobs data have raised the odds for Federal Reserve to cut rates for the first time in September this year.

This has rejuvenated interests in REITs as the interest rate-sensitive sector is expected to benefit in several ways:

• lower cost of debt could lift distributable income;
• a lower discount rate would lift the value of the assets; 
• lower cost of funds could spur M&A activities.

Capitaland Integrated Commercial Trust (CICT) and Capitaland Ascendas REIT, the two REITs with largest market cap, are priced at premium to book as at 19 July 2024.

They joined the trio - Mapletree Industrial Trust, Keppel DC Reit and ParkwayLife REIT - which have traditionally traded above book. 

Even logistics plays AIMS APAC REIT and Mapletree Logistics Trust are hovering at end-Mar book value.

FY2024 distributions may still face pressure 

#1- Expect borrowing costs to fall only from FY25E

Any adjustments to the borrowing costs are likely to be felt in FY25E, as the majority of the REITS have more than 60% of debt on fixed rates.

The effective interest rates are still expected to rise through 2024. The impact is more significant for those with loans that were previously secured at low rates and due for refinancing this year. We estimate a 0.2% to 1%-point increase in average cost of borrowings across the REITs, due to debt refinancing or roll-off of interest-rate hedges.

#2- Strong S$ will impact distributable income and book value in FY24E

Year-to-date, S$ has strengthened against regional currencies, including Yen (+10.2%) and RMB (+0.7%). It is only weaker against Pound Sterling (-5.0%), US$ (-2.6%) and HK$ (-1.7%), and flat against Euro, A$ and Ringgit.

REITs with overseas assets are likely to report lower 1H24 DPU. This would also affect translated book value. 

Most affected are those with assets in Japan and China. On the other hand, REITs with US and UK assets might record gain in book value.

#3- Credit constraints to drive divestments

Singapore’s 2Q24 advance estimated GDP growth of 2.9% (1Q24: 3.0%) was underpinned by higher growth in construction and positive 0.5% growth in manufacturing, while growth rates eased in other sectors. 

US data also pointed to a slowdown in 2024. 1Q real GP growth was 1.4% seasonally adjusted annualized return with downward revisions in consumer spending. Presidential candidate Donald Trump have proposed more tariffs if re-elected. Higher tariffs could fuel inflationary pressures, further dampen consumption. 

All these are likely to weigh on credit outlook, rendering it more costly to raise debts. We expect REITs to actively seek divestments to fund improvement capex and working capital. 

Divergence in outlook across sub-sectors 

#1- Singapore office face near-term supply pressure

According to JLL, global uncertainty amid higher cost environment is weighing on demand for office space in Singapore. 

Near-term supply of some 1.5 million sq ft of new space will come on stream in 2024/2025. The gross effective rent in Singapore CBD Grade A office was S$11.50 psf per month in 2Q24, up 1.6% yoy. JLL expects rent growth to remain modest for the rest of 2024.

Singapore office REITs are still enjoying occupancy at above 95%. While a potential slowdown in Singapore’s economic growth could lower demand for office space, tenants could also be more inclined to renew leases rather than spend to relocate.  

Occupancy in CBD grade A space could remain high as tenants take advantage of the new supply to relocate from business parks and other fringe regions.

Current rents are some 7% to 14% higher than the REITs’ expiring rents. Still, we expect renewal rents to be flat as landlords prioritise occupancy rates to preserve income and asset value.

#2- Peaking retail and hospitality demand

After a short spike in Feb festive season, Singapore retail sales excluding motor vehicles resumed the decline that began in Oct 2023. May retail sales was flat yoy (Apr: -4.5%). 

Growth in June visitor arrivals have also slowed to 10.7% yoy (May: 15.3%). Total visitor arrivals have eased 15.6% from the peak in March. Hotel RevPAR and occupancy rates fell in tandem. 

Fading of revenge travel, strong S$, higher costs and less MICE events in 2Q have contributed to the decline. This could also affect footfalls at retail malls on core Orchard shopping belt.

On a positive note, hotel room supply has remained muted. URA’s data shows 4,554 rooms are under construction, a 7.3% increase in potential supply. But these include serviced apartments which have a minimum stay duration of 7 days. 

#3- Warehouses are the strongest assets in industrial subsector

Warehouses command high occupancy rates of above 90%, and rental growth of 2.0% qoq in 1Q24, and was the bright spot in the industrial sector. 

Port congestion and higher manufacturing output likely contribute to the strong demand. On the other hand, business parks remained out of favour with consolidation in the tech/finance sector and more choices in CBD office space.

According to JTC, about 1.6 million sqm or 3.0% of new space will be added in 2024 and 1.0 million (+1.9%) in 2025, which could add pressure to rental and occupancy rates in the next two years, in our view. 

The authority’s recent cut back on the government land sale in 2H24 to 5.8ha (from 7.2ha in 1H24) could provide some breather. Still, the looming threat of oversupply exists, if industrial activities do not pick up at the same pace.

#4- Healthcare are the safest bets

The lower visitor arrivals also reflect reduction in medical tourists seeking treatment at the private hospitals in Singapore. Factors that keep them from coming are a strong S$, higher costs for airfare and accommodation, and improved healthcare standards in their home countries.

Nevertheless, the healthcare REITs are less impacted as they have entered into master leases with hospital operators. Both operators have reported revenue growth in 1Q24.

IHH Bhd, which runs the hospitals owned by ParkwayLife REIT, grew Singapore revenue by 17.8% in 1Q24. PT Siloam International Hospitals TBK, the operator of First REIT’s Indonesian hospitals, reported 14% higher revenue and gross profit in 1Q24. 

#5- Data centres are still relevant

As with healthcare assets, data centres generally signed long leases with tenants, mainly due to the higher cost in relocation for the tenant, and difficulty in replacing existing tenants if the asset is fully-fitted to the tenant’s specifications. While the long leases lift the value of the assets, they also present a different set of challenges.

Keppel DC REIT’s tenant at Guangdong Data Centres 1 and 2, Guangdong BlueSea Data Development, defaulted on 5.5 months of rent in FY23. This shaved FY23 DPU by 6.5% (0.649 cents). Keppel DC REIT have not collected rental payment from this tenant since then. While it might walk away from completing the purchase of Data Centre 3, Keppel DC REIT continues to work with BlueSea on a recovery roadmap. This would imply that FY24E DPU is likely to decline. The asset value should also be lowered to account for the lost income.

Still, we remain sanguine on this subsector. Data centres are an essential asset class with a longer income stream, underpinned by cloud-based computing and data storage requirements.

#6- Weak retail sales in China

China June retail sales grew by a modest 2% yoy (May: +3.7%), a sharp fall from the 3.7% growth achieved in the first six months of this year. On a mom basis, June’s retail sales were down 0.12%. 

Weak consumer sentiment will exert pressure on occupancy rates and rental for the China malls and e-commerce operators. 

Share prices of the Chinese retail REITs have declined between 1.5% to 61.8% year-to-date. Even at price to book of 0.56x to 0.82x, we see risk of further decline in DPU and asset value which could take gearing higher.

Post-pandemic slowdown in e-commerce demand have also affected demand for logistics assets. Mapletree Logistics expects negative rental revisions in China warehouses to persist over the next few quarters, with expiring rental rates being marked to markets. China accounted for 19.2% of FY24 revenue. About 13.2% of assets have leases expiring in FY25 are located in China. 

#7- US office REITs not out of the woods yet

Two out of the three US office REITs have suspended distribution, till end 2025 at the earliest. Prime US REIT paid just 10% of its 2H23 DPU to preserve capital, as aggregate leverage reached 48.1% at Mar-24. It is in the process of refinancing a US$600 million credit facility which will mature on 19 August 2024. 

Fundamentally, we think the US office assets are not out of the woods yet. The slowing economy and delayed rate cuts would cause tenants to hold back expansion plans and rethink their office space needs.

To recapitalize their balance sheet, the REITs are expected to divest assets, and in a still unfavourable market, which probably explains them trading at low P/B of 0.24x. We see meaningful share price recovery only when the REITs are able to resume normal distribution.

What would Beansprout do?

After June’s initial 0.25% rate cut, the ECB is expected to have two more cuts of 0.25% each this year, in September and December. Confidence in the Fed’s first rate cut in September has also grown with the weak retail sales and jobs data. 

While REITs are expected to benefit, the impact is likely to be felt only from FY25E, if the cuts take place in 4Q24. 

For the coming 2Q24 earnings reports, we expect borrowing costs to continue to climb and DPU to adjust downwards. We also expect some downward revisions in book value from the stronger S$ versus the regional currencies, Yen and RMB.

We think REITs with Singapore office assets are likely to fare better in preserving DPU and asset value. 

Weaker consumer spending is likely to affect the Retail and Hospitality REITs. We would avoid the REITs with China retail assets.

You can download our full REITs outlook report here. 

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