Singapore REITs - DBS Research 2023-01-17: Time To Increase Exposure

• Cooling inflation data adds impetus to a possible tone down in FED hikes and a pause by 1Q23.
• Historical data indicates that S-REITs turn strong outperformers during FED pauses.
• China re-opening fuels positive sentiment; improving outlook on the back of thawing supply chain disruptions.
• S-REITs trade at attractive yield spreads of 3.4%.

Pays to be early

• After hitting a peak in Oct’22, the general interest rates environment in Singapore has taken a breather. The Singapore 10-year government bond yield as of writing stands at 2.8%, close to ~60 basis points off the peak seen in Oct 2022 on the back of cooling inflation outlook and a more modest economic backdrop. Shorter term interest rates (SORA) have declined by a similar level although remaining at slightly elevated levels at ~3.2%.
• The S-REIT index performance has also seen relative strength as of late, with the index up ~0.42% over a month or ~0.46% since the start of 2023. Overall, we are encouraged that news flow has played out according to our expectations, with the news and optimism of China’s re-opening coming-in fast, boosting market optimism that supply chain constrains will ease and the pent-up demand from Chinese consumers for travel and consumption will be a boost for selected industries.

Inflation print continues to soften; implies that a FED pause is upon us.

• The US inflation print has continued to soften as of Dec’22, with headline and core CPI in line with consensus at - 0.1% m-o-m and 0.3% m-o-m respectively, according to our DBS economists. As such, with further downshift in inflation rates, we believe that there is sufficient reason for the FED to tone down further hikes.
• As such, with the FED approaching the end of the current rate hike cycle, we believe that headwinds that have weigh the S-REIT prices down in 2022 will slowly dissipate and turn into tailwinds.

Sector should recapture outperformance once FED stops hiking.

• As we approach the end of the rate hike cycle coupled with optimism from the recent “China reopening” wave, we noted that the S-REITs underperformance against the STI has also closed over time, eking out a slight outperformance in Dec’22.
• In addition, we note that S-REITs who have a bigger exposure to China/Hong Kong (retail, office) have performed better on relative terms compared to peers in Dec’22. In our conversions with investors in recent weeks, we noted that China’s re-opening theme remains firmly at play with names such as Mapletree Pan Asia Commercial Trust (SGX:N2IU), CapitaLand China Trust (SGX:AU8U) and hospitality S-REITs such as CapitaLand Ascott Trust (SGX:HMN), CDL Hospitality Trusts (SGX:J85), Far East Hospitality Trust (SGX:Q5T) garnering most queries and we believe will continue to see good flows heading into the results season come the second half of Jan’23.
• That said, we expect this re-opening theme to remain dominant heading into 1Q23 on the back of positive implications from China’s border relaxation. We retain our view that the retail S-REITs, and China-focused and hospitality S-REITs, will remain subsectors of focus in immediate term.
• From a yield perspective, we are attracted by the China-focused S-REITs FY23F yields of 8.6%, above its +1 standard deviation. We believe that Singapore-focused retail S-REITs resilience have been mispriced at yields that remain its historical average. While we note that hospitality S-REITs yields are close to mean, the dynamic nature of its RevPAR growth leaves room for surprises, especially on the back of China’s travel resumption.
• Of noteworthy are yields in the US office S-REITs and European focused S-REITs which are way above its +1 standard deviation levels. That said, we see potential NAV erosion coupled with cuts to dividends as risks in the subsector that prevents us from turning more constructive in those names at present.

S-REITs to find bottom in 1Q23

• Overall, we remain constructive on S-REITs and we believe the sector’s bottoming out is in sight. Looking at the relationship between US REITs (RMZ US) and S&P, S-REITs and the STI in past rate hike cycles back in 2015-2018, and the pause post-Dec’18, we saw that in the period of a rate pause, returns were generally positive. In fact, we note that during a rate pause, S-REITs outperformed the STI by almost 2.5x over a six-month period, maintaining this outperformance over a longer one-year period.
• In fact, we found that S-REITs troughed roughly two months prior to the last rate hike back in 2018, with the S-REITs providing investors with an additional 200 basis points of outperformance against the S-REITs.
• Assuming this relationship still holds in the current rate hike cycle, we believe that S-REITs will bottom sometime in Jan’23- Feb’23, if the DBS economist view of a FED pause by end of 1Q23 materialises.

China re-opening an impetus for a further re-rating.

• The market optimism of China’s gradual re-opening and border relaxation will have positive implications with our picks Mapletree Pan Asia Commercial Trust (SGX:N2IU), CapitaLand Ascott Trust (SGX:HMN), and CapitaLand China Trust (SGX:AU8U) most leveraged in exposure.
• We believe that the focus will then move towards the impact of a recession, and we believe that suburban retail (Frasers Centrepoint Trust (SGX:J69U), Lendlease REIT (SGX:JYEU), CapitaLand Integrated Commercial Trust (SGX:C38U)) and industrial names (CapitaLand Ascendas REIT (SGX:A17U), Frasers Logistics & Commercial Trust (SGX:BUOU), CapitaLand India Trust (SGX:CY6U)) are names that offer better relative DPU resiliency with capacity for upside surprises.