Singapore Reits – Strength Of balance sheet being tested

Excerpts from UOBKayHian report

• The rapid surge in interest rates affects Singapore Reits (S-REITs) who have not adequately hedged their cost of borrowings.
• We cut DCREIT’s 2023 DPU by 15% but upgrade the S-REIT to BUY after the recent 35% sell-off. MLT has only 11% of its borrowings exposed to rising interest rates.
• Stay invested in hospitality, retail and office REITs as reopening plays.

BUY ART (Target: S$1.31), FCT (Target: S$2.74), FEHT (Target: S$0.77) and LREIT (Target: S$0.95). Maintain OVERWEIGHT.

The Fed’s renewed fervour to clamp down on inflation

The Fed has accelerated the tempo of interest rate hikes to quell inflationary pressures. It hiked the Fed Funds Rate by a massive 75bp to 1.50% after the FOMC meeting on 15 Jun 22.

Based on the Fed’s dot plot, the median projected path for Fed Funds Rate would hit 3.4% by end-22 and 3.8% by end-23. The forecast translates to four hikes totalling 200bp in 2H22, and we expect another 75bp hike on 27 July.

The rate hikes are front-loaded in 2022 and the intensity of rate hikes could ease after the FOMC meeting on 21 Sep 22.

Interest rates in Singapore have moved up accordingly

Higher inflation and the Fed’s intervention have caused short-term interest rates to surge. The US yield curve has flattened, indicating a slowdown in economic growth.

Fortunately, the 10-year – 2-year term spread has stayed marginally positive at 0.1%. The current short-end of the yield curve implies forward short-term interest rates at 2.7% for one year, 3.4% for two years and 3.4% for three years.

Three-month SIBOR and three-month compounded SORA have rose 147bp and 57bp respectively to 1.91% and 0.76% in 1H22. UOB Global Economics & Markets Research forecasts three-month SIBOR and three-month compounded SORA to reach 2.75% (+2.31ppt yoy) and 2.29% (+2.10ppt yoy) respectively by end-22.

Singapore Reits recommendation

Maintain OVERWEIGHT. S-REITs are not out of the woods yet but the gradual easing of inflationary pressure provides some respite. Real estate is a hedge against inflationary pressure, which could potentially push rents higher.

Downside for the S-REITs sector is limited to 13.6% if distribution yield yield spikes to 2x SD above long-term mean.

Singapore Reits – The good, the bad and the ugly

SASSR has the most conservative aggregate leverage of 26.2%. Conversely, SUN and MUST are more highly geared with aggregate leverage
of 43.3% and 42.8% respectively. LREIT hedges 90% of its borrowings on fixed rates.

CICT, KORE and MUST also have a high proportion of borrowings on fixed rates of 85%, 84.2% and 86.5% respectively. DCREIT and SUN hedge a lower 50% and 51% of their borrowings to fixed rates.

Impact of higher interest rates

We now expect US Fed Funds Rate to hit 3.25% by end-22 (previous: 2.5%). We have factored in the negative impact on DPU from the accelerated hikes in interest rates around the globe based on forecasts by UOB Global Economics & Markets Research.

On average, we have adjusted 2023 DPU lower by 2.1% for 20 S-REITs under our coverage.

You can find the full report here and Singapore reits website here