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Singapore REITs - Still awaiting the elusive 2016 rate hike
What is the news?
- Expectations have been rising in recent months for Fed rate hike in December Rising expectations in recent months for a December rate hike by the Federal Reserve may have gotten investors jittery about the knee-jerk reaction that might be caused to the REIT markets.
- Current polled odds from Bloomberg for a December rate hike stand at c.67%, an increase from a mere 7.7% on 27 June 2016, the Monday after the Brexit referendum.
How do we view this?
Different causes for investors’ concerns
- REIT investors’ concerns over rising interest rates are manifested in several ways.
- Firstly, rising interest rates impact REITs in a few major ways, most notably in rising credit costs since this represent the biggest cost component for REITs.
- Traditionally viewed as quasi-yield instruments, rising interest rates also narrows the spread of REIT yields vs the risk-free yield, defined as the country’s 10 year government bond yield.
Global interest rates on a downtrend
- While the Federal Reserve prepares to hike rates for only the second time since the Global Financial Crisis (GFC), other major central banks such as the European Central Bank (ECB) and Bank of Japan (BOJ) continue to adopt loose monetary policies.
- Global interest rates have generally trended down, with the Eurozone and Japanese 10 year bond yields hitting negative territory. The downward trend in long term government bond yields has enhanced the attractiveness of REITs.
REITs do perform in a rising interest rate environment. Even outperformed mainboard index
- During the last rate hike cycle from November 2004-2007, Federal Fund rates moved up from less than 2% to around 5% in three years. In that same period, the major REIT indices correspondingly improved. The US, Australian and Singapore REIT indices gained 32%* , 42% and 67% respectively. US and Singapore REITs indices also outperformed their mainboard indices’ gains of 26% and 53% respectively. Outside of the US, Japan, Australia and Singapore are the three largest REIT markets by market capitalization in Asia.
- With these statistics, we gather that the more important thing to note about rising interest rates is that rising rates accompanied by strong country growth would actually be beneficial to REITs, with improving corporate earnings and consumer spending power.
- What is also important is the bigger picture to consider given that Federal Reserve Chair Janet Yellen has repeatedly emphasized that the pace of rate hike will be slow and gradual and most probably “data-dependant”.
Measuring the historical performance of major regional REIT markets post GFC
- We take a closer look at the performance of the Australia, Singapore and Hong Kong REIT indices post GFC. These are the three largest REIT markets by market capitalization in Asiaex Japan. From 2010 post GFC until now, Hong Kong REITs have outperformed with a 102% return, followed by Australian REITs 59% and Singapore REITs 25%. Consequently, the stronger appreciation in the REIT prices of Hong Kong and Australian REITs has translated to lower gross forward yields vs S-REITs.
Current Yield Spreads for major REIT markets – ASX, US, Singapore
- Despite the lower gross forward dividend yields for US and Australian REITs, yield spreads vs their respective 10 year government bond yields appear to be more “attractively priced” with the Australian and US yield spreads trading at >1s.d. from the mean (2010 to present).
Advantages of investing in REITs vs Physical Properties – Table of returns for different asset classes
- Low interest rates amidst the easy monetary policies since the GFC have led to an influx of institutional and private investment capital into properties. Besides offering better liquidity, affordability (board lot size of 100 shares), accessibility to overseas and unique asset classes such as golf courses, hospitals and shopping malls, REITs also offer investors tax savings. While investors in physical properties have to fork out property tax and rental income tax, REIT investors are exempted from both capital gains and dividend taxes. On the REIT end, local REITs with locally sourced rental income are also exempted from tax, provided they pay out 90% of the income as dividends.
- REITs also offer investors access to professional management teams who are able to carry out asset enhancement initiatives to achieve higher rental yields on costs, which would be more difficult to achieve on an individual basis. An example will be the acquisition of Iluma Mall by CapitaLand Mall Trust (CMT) in 2011 for S$295m. Within two years of acquisition, after some asset enhancement initiative works, CMT achieved a yield on cost of 7.1% by 2013, a rental yield which outperformed even those of suburban malls at high 5s to 6%.
Investment Actions
- We re-iterate our Equal Weight call on the S-REIT sector.
Dehong Tan
Phillip Securities
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http://www.poems.com.sg/
2016-10-14
Phillip Securities
SGX Stock
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