Singapore REITs - DBS Research 2022-11-03: Hitting A Turn; Is Gearing Under Risk?

Singapore REITs - DBS Research | SGinvestors.io (SGX:)

Singapore REITs - Hitting A Turn; Is Gearing Under Risk?

  • Oct 2022 has been a mixed month for the S-REITs with S-REITs share price remaining weak in the start of the month on the back of heightened worries of a hawkish FED impacting forward growth projections for the S-REITs.
  • The S-REITs are down by 5.5% month-on-month but smaller dips are seen in the industrial S-REITs (bellwether) and hospitality focused S-REITs given strong operational results fueling optimism that the hospitality uptrend is still on track.

S-REITs' Financial metrics largely steady.

  • Overall financial metrics have held steady in our view, but note that overall interest costs inched higher in 3Q22 by 20 basis points on average (to 2.6%) mainly driven by higher refinancing rates and floating portions of the loans, which stand at ~75%.
  • While results are still underway, we have so far cut FY23 estimates ranging from 3%-6%, in view of our assumption that overall interest costs are set to rise by 80 bps in FY23. This new assumption will bring FY23F DPU growth to ~3% from ~6% growth we projected previously.

Interest costs inch higher in 3Q22

  • Interest costs inch higher. Tracking the financial metrics for the S-REITs, with reporting season still underway, we note that S-REITs have continued to maintain a high level of fixed rate debt at about 75% while on average cost of debt rose by 20 basis points q-o-q to an average of 2.6% (as of 3Q22). The increase largely came from a mix of refinancing done in the quarter and the floating rate portion of the their debt profile.
  • During the quarter, we have also revised our estimates to account that refinancing and higher base rates to drive average interest cost up by ~80 basis points by end of FY23.

Is a breach in gearing a risk for s-REITs?

Should we be concerned about S-REIT's asset value risk?

  • One of the emerging concerns raised amongst investors is the probability of S-REITs breaching their gearing (or aggregate leverage) limits and interest coverage ratio (ICR) given the rise in interest expenses which could outpace the rise in revenues and net property income (NPI) heading into 2023. From a gearing perspective, we remain comfortable that the most S-REITs should be able to keep within a 45% gearing ratio level, a level which market is watching closely.
  • While the Monetary Authority of Singapore (MAS) has revised guidelines to allow S-REITs to gear up to 50% , in the event that ICR ratios > 2.5x, we do not see the S-REITs heading there despite most meeting these criteria. This additional debt headroom in the low interest rates environment now become a headroom for S-REITs to manouvere in the event that gearing level inches higher when asset values decline.

Decline in S-REIT's asset values is not considered a breach in MAS guidelines.

  • According to the property funds guidelines, if we use 45% as an assumed gearing limit and ignore that higher 50% limit accorded to most S-REITs, if gearing heads above this level due to annual asset devaluations, it is not considered a breach in MAS rules as such an event is deemed to be out of control of the S-REIT manager hands.
  • That said, in that scenario, the S-REIT manager will not be able to take on more debt or deferred payments until it cures this situation.

S-REITs recent valuations have been stable.

  • S-REITs gearing levels average 36.5% but range between 33% to 39% across different sectors. While the rise in interest rates since the start of 2022 have raised questions about the sustainability of year end valuations for S-REITs, we believe that year-end net asset values (NAV) should remains fairly stable, especially for Singapore focused properties.
  • We note from recent reported result from valuation exercises by SPH REIT (SGX:SK6U) and Frasers Centrepoint Trust (SGX:J69U) indicated that capital values have remained quite stable with upside in values driven by cashflows improvement.

Upward pressure for portfolio yields to expand?

  • While the verdict is still out on whether how much will property cap rates rise during the year end, while there is upward pressure for cap rates to expand from current levels due to rising 10-year benchmark yields, we note that this is balanced by the still-strong cashflow growth for properties coupled with ample liquidity chasing for asset deployment opportunities.
  • This, in our view, will keep asset values stable for now, as reflected by the stable revaluations that selected S-REITs have undergone in the recent quarter. That said, if 10-year yields continue on the rise and stay high, we do not rule that cap rates will head higher in the medium term.
  • Using FY23F net property income (or net operating income) as a proxy in our analysis, for gearing levels towards 45% will mean that portfolio asset yields have to expand between 20 basis points up to 190 basis points, levels which we felt to be less likely in the current still positive operational outlook, where rentals remain on an upward trajectory heading into 2023.
  • That said, we notice that office S-REITs probably have less buffers that the other subsectors where a ~10% decline (or a 50 bps expansion in yields) could potentially drive gearing levels towards 45%.
  • That said, we notice that based on current S-REITs share price, the implied FY23F yields are generally higher that yields would have been at 45% gearing level for most subsectors (expect for industrial and retail S-REITs) imply that negatives are generally priced into current prices with market also pricing in risk in earnings decline.

Continue to read the report attached below for complete analysis with S-REIT data metrics.

Geraldine WONG DBS Group Research | Dale LAI DBS Research | Rachel TAN DBS Research | https://www.dbs.com/insightsdirect/ 2022-11-03