Sunday, 29 September 2013

Singapore REITS - As Dust Settles, Value Emerges?

The recent market selloff of S-REITs have taken the shine of S-REITs. Are S-REITs remain attractive investments, especially in a rising interest rate environment? 

Using sensitivity analyses, one can see that the magnitude of interest rate hikes that is being priced into the SREITs is far higher than the most bearish market scenario. If investors were to cherry pick wisely,certain SREITs might even present with considerable capital upside and attractive returns.

The key focal points to assess the impact of higher interest rates on SREITs:
1. Impact on distributions
2. Risk on NAV

1. Impact on distributions from higher interest costs

A hike in borrowing rates would increase interest expense via the REIT’s exposure to floating interest rates. S-REITs’ sensitivity to interest rates hikes is dependent on 2 main factors – their gearing level and the % of interest costs that is hedged into fixed rates.

From the following charts, note that FEHT, Cache, SGREIT and FCOT have 0% of debt expiring in FY13 and FY14, and REITs with >50% of debt expiring in FY13 and FY14 are CDREIT, MINT, CREIT and CRCT.


In a sensitivity analysis assuming a 50bps increase in the cost of debt, the impact is limited at <3%.  As a result, FY13/14 distributable income to decline by <3% for most REITs. P-Life and a-itrust will not see forecasted distributable income change, as both have hedged all its debts.

2. Risk on NAV through cap rate expansion

Book values should remain fairly safe. Whilst concerns about the impact of cap rates expansion negatively impacting book values are valid. While increasing base rates are likely to result in valuers and investors requiring a higher rate of return towards asset valuation and deals, any discussion of cap rate expansion is pre-mature at this point as the likelihood of such a scenario occurring will only be after a
period of interest rate increase and stabilization, as opposed to a immediate reaction to market concerns.

A more important consideration would be the actual physical market transactions, which might provide an indication of returns for the various real estate classes. On that front, we see potential risks coming from the office and industrial sector given that transactions have been most active in these two real estate sub segments.

S-REITs valuations to remain fairly stable as increases are largely income driven. S-REITs have generally taken a conservative approach towards their portfolio asset valuations. Upon discussing cap rates with various REIT managers and using the largest REITs in the various sub-sectors - industrial (A-REIT),retail (CMT) and office (CCT) – as indicators for cap rate movement, one can see that cap rates did compress by c25-50bps over the past few years; however the main driver for higher valuations has been income increases, which  will result in more sustainable book values (NAVs).

We note that for both A-REIT and CMT, on a like-for-like basis, both REITs reported valuation increases of 9.2% and 9.0% over 2010-2012, accompanied by increases in net property income of 7.4% and 10.0% respectively. This implies that the valuation increases were largely supported by income growth rather than cap rate compression. However, CCT’s portfolio (on a like-for-like basis, stripping out acquisitions), was higher by 8% in 2012 (vs 2010) but net property income increase was a paltry 2% over the same period. This indicates that cap rate compression over the past few years has been a main factor in the growth in its portfolio value. Based on this observation, there is an inherently greater risk of the office sector reporting higher asset devaluations compared to the retail and industrial sectors in the event of an expansion in cap rates in the future.

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