Singapore REITs - DBS Research 2022-10-26: Crossing The Refinancing Hurdle

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Singapore REITs - Crossing The Refinancing Hurdle

S-REITs' share prices rampaged on the back of upward trajectory in 10-year yields. With base rates ~200 bps higher, refinancing debt is a painful exercise but staggered expiry profile and high fixed-rate ratio of 74% are temporary shields
FY23F DPUs of S-REITs could see up to 9.0% downside, bringing headline yields back to 6.5% (from 7.1%)

The spike in global interest rates from the end of Sept 2022 to the first three weeks of Oct 2022 saw 10-year yields rising to 4.24%, up by close to ~50 basis points (bps) during the period. Similarly, the Singapore 10-year yields have spiked by 200 bps to 3.6% (as of 21 Oct), up from ~1.6% at the start of 2022.
S-REITs’ yields have also expanded in tandem with the rise in bond yields to reach 7.1% for FY23F. This implies a yield spread of close to 3.5% against the 10-year bond of 3.6%, in line with its historical mean.

The hike in FED rates have caused the SG 3Y/5Y rates to spike more than 200 basis points to date and is expected to hurt S-REITs’ distributable income growth in FY23.
In our scenario analysis, based on an assumed 3-year rolling refinancing profile, we estimate that refinancing rates could be close to 200 bps higher. However, the spread-out debt maturity profile coupled with high fixed-rate debt ratio of ~75% would be a near term shield, mitigating partially the overall cost of debt from an assumed ~2.5% to ~2.9%.
That said, we expect to cut FY23F DPU forecast for S-REITs by almost 9.0% and shave close to 70 bps off the headline yield of 7.1% to ~ 6.5%, which is still attractive, in our view.

What happens if debt is renewed at ~200 basis points higher? While we note that on average, S-REITs have fixed ~75% of their overall interest rates profile, the rise in base (especially the 3Y/5Y) swap rates to ~4.0% means that refinancing costs will likely be much higher when debt falls due in 4Q22 – 2023.
We did an analysis to consider higher refinancing costs on loans that are due to mature in FY22 and FY23 including a rise in the floating rate portion of the debt. Based on this scenario, we estimate that S-REITs' FY23F DPU could fall by ~9.0% on average but ranging from 0% to 19%, depending on the individual S-REITs’ refinancing profile and fixed-rate hedge ratio.
In terms of sectors, based on our scenario analysis, we estimate that we would see a higher drop in DPU in the office sector and retail focused, and hospitality subsectors (of up to ~13%) given their relatively higher gearing and debt expiry in FY23. The impact on Industrial and US office and SG retail S-REITs is less in this scenario analysis at < 10% potential downside to FY23F DPU.

Valuations have expanded; spreads have narrowed over time. With the decline in S-REITs' share prices accompanying the spike in in 10-year SG yields, we found that S-REITs’ FY23 yields have inched higher towards ~7.1%, representing a yield spread of close to ~3.5% against the spot 10-year yield of 3.6% as of 22 Oct 2022, back to close to the sector’s historical mean (2006 to year-to-date).
While the assumed interest rates could shave DPU estimates off by ~9%, this would bring FY23F headline yields towards the 6.5% level, compressing yield spreads to the ~3.0% level. If we apply a fair yield spread of ~3.5% to the revised spread, S-REITs should be trading close to ~7.0% on the back of projected 10-year yield of 3.5%. This implies that the sector could see downside of up to ~7% to fully reflect the interest rate hikes.

Yields are already close to “taper tantrum” or decade lows (excluding COVID-19 period). From a yield perspective, we found that most S-REITs are already trading close to levels at the 2013 taper tantrum lows (taken as the highest yields traded in 2013) or are at decade highs.
While the sector is faced with a myriad of risk factors ranging from interest rates, margin pressure and currency devaluation, we believe a substantial portion of these risk factors are priced in with a majority of S-REITs either trading at decade high yields or close to 2013 taper tantrum levels.
Looking at the assumed cut in FY23F estimates, we found that close to 60% of the S-REITs have reached yields at either taper tantrum levels or 10-year lows.
Investors looking for subsectors that can weather the effects of currency, interest rates and margin risks may consider the SG office and SG retail subsectors. Given their substantial Singapore focused footprint, they offer attractive entry points, especially when these stocks are already trading close to taper tantrum valuations.

Derek TAN DBS Group Research | Rachel TAN DBS Research | Dale LAI DBS Research | https://www.dbs.com/insightsdirect/ 2022-10-26