The Edge July 5: REITs offer
value after selloff
SINGAPORE REITs HAVE surrendered about a third of their gains in
just six weeks after a spectacular 55% rally since the start of 2012 powered by
the hunt for yield.
Following Fed chairman Ben Bernanke’s announcement last month that the US
central bank will start to wind down its monetary stimulus programme later this
year, REITs have been hammered as investors cashed out of what had been one of
the best-performing sectors for several quarters in the Singapore market.
The expected tapering of the Fed’s quantitative easing programme
led investors to believe interest rates will rise in the foreseeable future.
Higher rates could mean increased risks for REITs as they require funds to pay
for acquisitions or refinance existing debt.
Yields on 10-year Singapore government securities (SGS) jumped from about 1.4%
in early May to a two-year high of 2.8% late last month. They are now holding
around their long-term average of 2.6%.
The FTSE ST Real Estate Investment Index fell almost 19% in June from its
5-year high of 890.16 in mid-May. It is now holding just above 750.
With the selloff, REITs appear to be back in favour – at least among some
analysts.
David Lum of Daiwa, in a report dated July 3, upgraded the sector to “positive”
from “neutral”, noting that value has emerged. The sector’s weighted average
price-to-book ratio had come off from 1.25 times at end-April to 1.05 times at
end-June, he said.
“Although we cannot rule out further unit-price downside risks for S-REITs (triggered
by rises in the 10-year SGS yield), we can now declare with some confidence
that we believe the overall S-REITs sector is no longer overvalued,” he said.
A notable feature of the recent weakness in REITs, according to Lum, was that
the spread between their weighted-average dividend yield and the yield on
so-called risk-free 10-year SGS did not change much, hovering between 3.4% and
3.7%.
That was because the increase in the SGS yield was largely offset by the
higher dividend yield from REITs arising from their selloff.
“Yield spreads usually narrow when the market’s perception of S-REIT risk
recedes and investors become more comfortable with their fundamentals and
willing to accept lower yields (relative to risk-free rates),” said Lum.
“Although the Fed’s recent pronouncements – that it would begin tapering if the
gradual improvement in economic conditions supports such a move – have effectively
eliminated any prospects for yield-spread compression, we see little
justification for yield spreads to widen.”
Yield spreads typically expand when investors expect fundamentals to turn for
the worse. In effect, Lum expects spreads to remain stable for the next one to
two quarters.
Daiwa’s top pick is Suntec REIT, on which it has a price target of
$2.01. The broking house also recommends CapitaCommercial Trust ($1.65
price target), Ascott Residence Trust ($1.42) and CDL
Hospitality Trusts ($1.85).
UOB KayHian has a different opinion on REITs. On July 3, it downgraded the
sector to “market-weight” from “overweight”, mainly on the view that borrowing
costs will rise. An increase of 100 basis points in interest rates will reduce
the price targets of the REITs under its coverage by about 8.1%, it said.
Even so, as economies recover, REITs will evolve from being “yield vehicles” to
“growth vehicles”, UOB said. This should help mitigate the impact of higher
interest rates on their income.
UOB’s preference is office and industrial REITs, which it expects will benefit
from a pickup in rentals. Suntec REIT, CapitaCommercial Trust and Ascendas
REIT are its top picks.
