Singapore REITs - UOB Kay Hian 2017-03-07: Déjà Vu All Over Again

REITs – Singapore - UOB Kay Hian 2017-03-07: Déjà Vu All Over Again Singapore REITs Rate Hike ASCENDAS REAL ESTATE INV TRUST A17U.SI FRASERS LOGISTICS & IND TRUST BUOU.SI CAPITALAND COMMERCIAL TRUST C61U.SI FRASERS HOSPITALITY TRUST ACV.SI

REITs – Singapore - Déjà Vu All Over Again

  • We expect a muted response to the upcoming rate hike. We view any share price weakness on rate hike concerns as an opportunity to accumulate at attractive levels.
  • The longer debt maturities and a higher proportion of fixed rate debts will further mitigate the impact. 
  • We prefer deep value and diversified REITs, with exposure to the industrial business park and hospitality spaces. AREIT, FLT, CCT and FHT are our top picks. 
  • Maintain OVERWEIGHT.



WHAT’S NEW

  • The US Federal Reserve Open Market Committee (FOMC) will conduct its policy meeting next week to decide on the first of three planned rate hikes this year. 
  • Futures traders place the probability of a rate hike in Mar 17 at 96%, as data from Bloomberg Fed Fund Futures show.


ACTION


Maintain OVERWEIGHT, interest rate hike priced in. 

  • Fed fund futures imply a 96% likelihood of a hike next week. The impact of an interest rate hike on S-REIT distributions is minimal in the near term (0.4-4.6% drop in DPU for a 100bp rise) due to long debt maturity periods and high proportion of fixed rate debts. 
  • We prefer deep value and diversified REITs with exposure to the industrial business park and hospitality spaces.
  • Our top picks are AREIT, FLT, FHT and CCT.


ESSENTIALS


First of the three planned rate hikes likely next week, although jury is still out on the rest. 

  • All signs point to a rate hike next week, with both futures traders and the equity market in broad agreement. This view is also bolstered by a strong US labour market that is at or close to full employment, with the US unemployment rate at 4.8% and weekly jobless claims near a 44-year low. However, reasons that would have the Fed pausing on accelerating rate hikes in 2017 include: 
    1. continued volatility in Europe with rising anti-globalisation sentiment post Brexit, 
    2. depressed growth prospects in mature Asian markets like Japan, where interest rates are only marginally positive, and 
    3. slowing growth in China, with its 2017 GDP growth target lowered to 6.5%, from 6.5-7% in 2016.
  • These could create a feedback loop in the US economy, especially as foreign contributions make up about 44% of S&P 500 companies’ sales figures in 2015, according to S&P Dow Jones Indices.

Muted response seen in the past two rate hikes, third unlikely to deviate much.

  • The REITs share price performance was in line with the market in the weeks of the past two rate hikes. 
  • REITs outperformed the market by 5-7% post the 3- to 6-month period after the first rate hike on 16 Dec 15, and underperformed by 0.5-3% in the 1- to 3-month period post the second rate hike in 14 Dec 16. 
  • The muted response reflects the pricing in of the rate hike ahead of the actual move.

Best of both worlds – Yield play on downturn and growth play on upturn. 

  • In light of a potentially depressed global growth outlook hampering further interest rate acceleration, we opine that REITs could continue to be an attractive asset class.
  • However, if the recent share price rally turns out to be a precursor to the cyclical recovery going forward, REITs will transition from being viewed as yield vehicles to growth vehicles and continue to deliver strong performances unlike traditional yield plays. 
  • We prefer deep value and diversified REITs with exposure to the industrial business park and hospitality spaces. 
  • Our top picks are AREIT, FLT, FHT and CCT.

Financing impact also minimised due to diversified sources of funding. 

  • The average debt maturities across REITs within our coverage have doubled to about 3.4 years, from around 1.7 years during the global financial crisis in 2008, implying the lower likelihood of near-term debt refinancing. 
  • The lengthening debt maturities have been bolstered by tapping debt markets, as REIT managers issue bonds ie medium-term notes. Examples include AREIT and CMT, with MTN loans maturing as far as 2029 and 2031 respectively.

Positive US REIT and S-REIT returns during rate hike cycles

  • Positive US REIT and S-REIT returns during rate hike cycles, with the US REITs (FTSE NAREIT All Equity Total Return Index) doubling from mid-04 to end-06 when US Fed Funds Target Rate (FFTR) rose 425bp from 1% to 5.25%. 
  • US REITs also gained 3% during the previous rate hike cycle in mid-99 to mid-2000 when FFTR rates were hiked 175bp to 6.5% from 4.75%. 
  • Similarly, S-REITs rallied in the last rate-hike cycle, with the FTSE ST REIT Index surging 83% from 500 in mid-04 to 914 by end-06, despite the 3M SIBOR more than tripling, rising from 0.75% to 3.44% over the same period. As REITs rallied, yields were compressed by 230bp, falling from 7% in mid-04 to 4.66% by end-06.
  • The present cycle differs with regard to the outlook of growth being relatively better for the US economy. However, the interdependencies as highlighted earlier would limit the number of rate hikes planned by the Fed, keeping REITs attractive as yield instruments.
  • When the rates eventually rise on back of global growth, REITs will come into focus as equity instruments.









Vikrant Pandey UOB Kay Hian | Derek Chang UOB Kay Hian | http://research.uobkayhian.com/ 2017-03-07
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