Following Fed chairman Ben Bernanke’s announcement last month that the US central bank will start to wind down its monetary stimulus programme later this year, REITs have been hammered as investors cashed out of what had been one of the best-performing sectors for several quarters in the Singapore market.
Yields on 10-year Singapore government securities (SGS) jumped from about 1.4% in early May to a two-year high of 2.8% late last month. They are now holding around their long-term average of 2.6%.
The FTSE ST Real Estate Investment Index fell almost 19% in June from its 5-year high of 890.16 in mid-May. It is now holding just above 750.
With the selloff, REITs appear to be back in favour – at least among some analysts.
David Lum of Daiwa, in a report dated July 3, upgraded the sector to “positive” from “neutral”, noting that value has emerged. The sector’s weighted average price-to-book ratio had come off from 1.25 times at end-April to 1.05 times at end-June, he said.
“Although we cannot rule out further unit-price downside risks for S-REITs (triggered by rises in the 10-year SGS yield), we can now declare with some confidence that we believe the overall S-REITs sector is no longer overvalued,” he said.
A notable feature of the recent weakness in REITs, according to Lum, was that the spread between their weighted-average dividend yield and the yield on so-called risk-free 10-year SGS did not change much, hovering between 3.4% and 3.7%.
“Yield spreads usually narrow when the market’s perception of S-REIT risk recedes and investors become more comfortable with their fundamentals and willing to accept lower yields (relative to risk-free rates),” said Lum.
“Although the Fed’s recent pronouncements – that it would begin tapering if the gradual improvement in economic conditions supports such a move – have effectively eliminated any prospects for yield-spread compression, we see little justification for yield spreads to widen.”
Yield spreads typically expand when investors expect fundamentals to turn for the worse. In effect, Lum expects spreads to remain stable for the next one to two quarters.
Daiwa’s top pick is Suntec REIT, on which it has a price target of $2.01. The broking house also recommends CapitaCommercial Trust ($1.65 price target), Ascott Residence Trust ($1.42) and CDL Hospitality Trusts ($1.85).
UOB KayHian has a different opinion on REITs. On July 3, it downgraded the sector to “market-weight” from “overweight”, mainly on the view that borrowing costs will rise. An increase of 100 basis points in interest rates will reduce the price targets of the REITs under its coverage by about 8.1%, it said.
Even so, as economies recover, REITs will evolve from being “yield vehicles” to “growth vehicles”, UOB said. This should help mitigate the impact of higher interest rates on their income.
UOB’s preference is office and industrial REITs, which it expects will benefit from a pickup in rentals. Suntec REIT, CapitaCommercial Trust and Ascendas REIT are its top picks.