Singapore REITs - Phillip Securities 2018-03-26: First Rate Hike In 2018 And The Implications For S-REITs

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Singapore REITs - First Rate Hike In 2018 And The Implications For S-REITs

• As widely expected, The Federal Reserve, raised rates by 25 basis points to 1.75% last week, while maintaining its forecast for three rate hikes total for 2018. 
• Even as the Fed upgraded its outlook for the economy, it expects near term inflation in 2018 to remain benign, with both core and headline inflation projection coming in at 1.9%.
• The news was largely shrugged off in terms of its impact on REITs with the FTSE S-REIT Index down a marginal -0.2% the day after the rate hike. Nonetheless, since the turn of the year, the S-REIT sector looks to be pricing in some of these headwinds from the macro front this year, with the FTSREI down -5.4% YTD vs the STI’s +0.1%. 
• We highlight some of the queries investors may have at this juncture in face of the impending further rate hikes.

1. The Fed just raised rates for the first time in 2018, and signaled for another two for 2018. What are the implications on the S-REIT sector? 

• The rate hike was widely expected as per the Fed’s earlier guidance. In fact, following the hike, market expectations of four rate hikes or more this year actually fell. This is probably due to Fed Chairman Powell’s comments re-affirming gradual rate hikes and that the present Trump administration’s trade policies could pose a concern for businesses.
• Interesting to note is that despite raising projections for economic growth to 2.7% from 2.5% and lowering unemployment forecast, headline inflation expectations remain unchanged at 1.9% and 2% for 2018 and 2019 respectively.
• Based on the Fed’s latest assessment and if this pans out, it should continue to be an accommodative environment for S-REITs with strengthening economic growth and tepid inflation which allows the Fed to maintain a gradual pace of rate hikes.

2. What is the impact on S-REITs’ DPU from these rate hikes? 

• On average, we note that c.80% of S-REITs across the various sectors have at least 70% of their debt hedged on fixed rates in anticipation of higher interest costs. This helps mitigate the impact of rising interest rates on 2018e DPU.
• For the REITs under our coverage, we estimate DPU will be negatively impacted 1-3% by a 100bps increase in financing costs from current, assuming current interest rate hedging status.
• Assuming a zero hedging scenario, DPU could be negatively impacted 8-12%.

3. What is the outlook for each S-REIT sector? 

• Apart from retail, all other sectors - office, industrial and hotels - generally face a positive scenario of tapering supply after a peak in supply in 2017.
• The easing of supply in 2018 should build a base for rentals to start climbing up. This should mitigate the magnitude of negative rental reversions we are expecting for the retail, industrial, and office sectors.

4. Apart from interest rate hikes, how will some of the other regulatory changes announced during Singapore’s Budget 2018 affect S-REITs? 

• Singapore-listed REIT exchange traded funds (ETFs) will no longer be subjected to the 17% corporate tax on the specified income distributed to the unitholders.
• Expected to be enacted on or before 1 July 2018, this change will even the parity of tax treatments between individual S-REIT counters and S-REIT ETFs.
• Demand will inevitably flow down to the three Singapore-listed ETFs and correspondingly, the S-REIT portion of the entire Singapore-listed REIT ETF pie. Total market capitalisation of all three REIT ETFs currently stands at S$264.71 million, in comparison to the S$80.9 billion market capitalisation of the entire S-REIT market.

5. Where do S-REITs stand now compared to historical valuations and the valuations of regional REITs? 

• At 5.3%, S-REITs offer one of the highest absolute yields amongst major REIT markets of the US, HK, Japan and Australia. However, current yield spread of c.2.9% is at a -1s.d. level from post-GFC average. 
• We note that post-GFC, there were only 2 periods of time when the yield spreads compressed below current levels: in 2010 (for a 2-month period) and 2013 (for an 8- month period).

6. What are key risks going into S-REITs now? 

• Macroeconomic factors - in particular, the US interest rate hikes - continue to be the paramount risks to look out for for S-REITs going forward. Fed’s balance sheet tapering could also cause upward pressures on yields.
• While three interest rate hikes are expected in 2018, word on the street – or rather, nuanced through Powell’s debut FOMC speech on 21 March 2018, indicate a likelihood of a fourth interest rate hike.
• However this does not necessarily spell doom and gloom if the rate hikes are in response to improving economic conditions.
• Rising interest rates is a headwind, but it does not necessarily mean lower prices.

Dehong Tan Phillip Securities | Tara Wong Phillip Securities | https://www.stocksbnb.com/ 2018-03-26

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