Singapore REITs outperformed in in the last couple days, ending last week strong. The main catalyst was due to the lower CPI data, which measures inflation in the US.
The CPI declined by 0.1% from May, putting the 12-month rate at 3%, around its lowest level in more than three years.
Excluding volatile food and energy costs, the so-called core CPI increased 0.1% monthly and 3.3% from a year ago. The annual increase for the core rate was the smallest since April 2021.
Following the latest CPI data, markets are now expecting two Fed rate cuts this year, with the first possibly in September. Before this, the expectation was for one cut by the end of this year.
Fed chairman Jerome Powell turned more dovish in recent days when he testified before the US Congress to present the central bank’s semi-annual Monetary Policy Report.
He warned that reducing policy restraint too little or too late could unduly weaken economic activity and employment.
The US Fed’s dual mandate is to promote maximum employment and stable prices. With stable prices under control, focus now turns to employment as the unemployment rate rose to 4.1% from 4.0% in May and 3.7% back in December 2023.
REITs and other indebted companies rallied on hopes of earlier and higher rate cuts, which would not only reduce their interest cost but also boost economic growth.
The iEdge S-REIT index which is regarded as Singapore’s S-REIT benchmark, rallied 3.6% on Friday after the CPI data was released overnight. The index also rose 2.9% the day before the CPI data was released, marking a total 6.6% gain in two days.
Looking at the top performers on Friday, due to the significant sell down, it is not surprising that many of the top performers are REITs with US exposure or REITs with higher debt levels. We can also see that it was a broad based rally, with the big names mostly recording strong performances in alignment with the broader index.
Historic REIT performance
Of the 40 REITs listed above, 29 delivered negative total returns, which includes dividend returns, over 3 years.
Of the 11 REITs that delivered positive total returns, 8 of them had annualised total returns of less than 5% which means that capital gains were next to nothing.
The 3 best-performing REITs were Far East Hospitality Trust, First REIT and AIMS APAC REIT.
Performance was also mixed across the 14 REITs backed by the 4 biggest sponsors – CapitaLand, Keppel, Mapletree and Frasers.
Of the 5 CapitaLand REITs, 3 of them, namely Ascendas REIT, Ascott Trust and the Integrated Commercial Trust were able to deliver a positive total return while the China & India Trusts both underperformed.
All 3 Keppel-related REITs delivered negative total returns, with Keppel Pacific Oak US REIT being the worse with -35.2% annualised total return
The 3 Mapletree-backed REITs also performed poorly, with MPACT & MLT both delivering negative total returns while MIT was able to eke out a 0.3% return.
Looking at Frasers, Frasers Centrepoint Trust being a Singapore focused Retail REIT, was able to deliver positive total returns, while Frasers Hospitality and Frasers Logistics & Commercial both delivered negative returns.
REIT valuations
The average dividend yield for the overall S-REIT universe is 7.9%, and the average P/B is at 0.74x
Looking at the price return index below, when compared to Sep 2010 levels, we can see that both the iEdge S-REIT index and FTSE ST REIT Index have largely not recorded any capital gains since Sep 2010.
Looking at the chart below on the left, should rates be cut, yields would decrease in line with benchmarks. The yield spreads are already below the 10 year average, as many of the S-REITs trade at a premium due to demand.
Looking at the chart above on the right, The index is trading close to 0.9x P/B value, which is below the 10 year average of 1.03x as well as the +1SD and peak levels.
REIT Fundamentals
The S-REIT universe mainly consists of the following asset types. We will provide a brief commentary to explain our view on their current and prospective fundamentals.
1) US Commercial assets
This is probably the worst-performing asset type on this list. US Commercial real estate has seen vacancies spike and rentals plummet. There are even horror stories of buildings being sold at a 90% discount to the last selling price. The continued high interest rates also do no favours to investors of real estate, who tend to have a loan-to-valuation ratio of at least 50-60%, if not more. There is no sign of a turnaround, and needless to say, we would not recommend this sector. Additionally, the US is one country where the Work From Home and Hybrid models still seem popular for now.
2) China assets
Chinese assets owned by S-REITs mainly consist of Commercial and Logistics assets. The Chinese economy has been lacklustre with limited fiscal and monetary policy boosts. The policies supporting the real estate sector have also been focused on residential real estate as this was the sector that was hit badly by the slowdown.
Distressed sales made up more than 20% of commercial real estate in 2023. Some of these distressed deals were made by residential developers in need of liquidity.
Demand for Chinese logistics assets has been affected by the shift in global supply chain as a result of the US-China trade wars, as well as slowdown in local consumer demand and an oversupply of warehouse space. Negative rental reversions are expected in the upcoming quarters, with the average occupancy at 78%.
3) Singapore assets
Singapore REITs have assets in Commercial, Retail, Hospitality and Logistics/industrial. Commercial assets in Singapore have also not done well but have outperformed global peers. The pandemic let companies to cut lease space, but the US-China trade war have led many companies to shift or set up their Asia headquarters in Singapore.
Singapore Retail assets have been extremely resilient, especially the suburban assets, as the Singapore economy remained relatively robust and stable with unemployment rates continuing to be low. Retail assets have evolved over the years since the onset of e-commerce. This asset class is likely to continue to remain resilient.
Hospitality assets have seen strong growth and double digit percentage rental reversions, with hotel demand supported by a wide range of events and general tourism travel. International flight capacity has recovered close to pre-Covid levels, with inbound flights from markets such as China, India and South Korea exceeding pre-Covid flight capacities. With limited new supply underpinning high occupancy in existing assets, optimists believe this is the start of a cyclical bull market for the industry.
Despite a weakening economy, Singapore logistics/industrial assets have been beneficiaries of the shifting supply chain, with strong positive rental reversions, especially for grade A and newer assets. While the business of key tenants may be impacted by the uncertain outlook for inflation, geopolitical tensions and risk of slowing growth in China and the world, these assets would likely still be in a better position compared to peers globally.
4) Data centres
This is likely the best performing asset class in the near term. Countries in Asia have been trying to attract investments from big tech companies to build data centres. After a period where some countries tried to stem the development of Data centres on fear of oversupply and stress on the power grid, it now seems to be a buoyant situation. It definitely seems to be the start of an uptrend, but one should always keep an eye for a heated market leading into a potential bubble.
Will the rally last?
REITs as a whole have not delivered any capital gains when compared to Sep 2010 levels, relying on dividends to provide returns. REITs are also cheaper then the long term average.
The longer-duration yields are used by lenders to price their debt, and borrowers expect to pay a rate that is calculated off the risk free rate. The US 3M yields are still at 5.3% while the 3M SORA in Singapore is now ranging around 3.6%-3.7%.
At the end of the day, while it is great that the likelihood and expectations of rate cuts have increased, the Fed has to actually reduce its benchmark overnight rates so that financing becomes cheaper, bringing relief to landlords. At the same time, lower interest rates will stimulate the economy and boost demand.
We think the rally will last, especially in sectors with fundamental tailwinds, but it may not be a smooth ride due to two main reasons, namely the high interest rates and because many of the S-REITs are diversified and will be afftected by shifts in fundamentals of some of their assets.
Because of dividend yield, REITs are one asset class that many believe is worth holding, and having time in the market versus trying to timing the market. We believe that getting in at these levels will allow investors to eventually reap the benefits of both time in the market and timing the market.
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