S-REITs’ prospects are looking up, but this is why they aren’t a buy

Mall on Singapore’s Orchard RoadMall on Singapore’s Orchard Road

Singapore REITs, or S-REITs, are showing improving operational prospects, especially in the office segment, but those positives are negated by rising yields, OCBC said.

The bank noted that in the first quarter, the average distribution per unit (DPU) fell 2.6 percent on-year, but that belied a more positive outlook, with the earnings of 19 of the 23 S-REITs under its coverage meeting expectations.

“We believe the operational outlook appears more positive, especially for the office sub-sector, whereby signing rents have improved firmly in tandem with the robust recovery in market rents,” it said in a note on Wednesday, forecasting market-cap-weighted DPU growth of 1.9 percent for the current financial year.

But the bank noted the FTSE Straits Times REIT Index, or the FSTREI, was down around 6 percent so far this year, while including dividends, the sector’s total returns were negative 3.4 percent year-to-date.

“We believe this decline has been driven by concerns over a rising interest rate environment, as government bond yields have also seen a spike since the start of the year,” the note said. It noted that the FSTREI was trading at a forward distribution yield of 6.0 percent, implying a spread of 334 basis points against the Singapore 10-year government bond yield, after that yield climbed to around 2.67 percent, from the around 2.0 percent level at the end of last year.

“Despite the share price correction year-to-date, valuations are still stretched, in our view,” OCBC said, noting the yield spread with the Singapore 10-year bond was well-below the five-year avearage of 410 basis points.

It kept a Neutral on the sector, with its Buy-rated preferred picks as Frasers Logistics & Industrial Trust, with a S$1.21 fair value, Frasers Centrepoint Trust, with a S$2.49 fair value, and Mapletree Greater China Commerical Trust, with a S$1.42 fair value.

“We continue to believe the office sector would achieve the strongest rental growth this year, while RevPARs [revenue per available room] for hospitality REITs have been encouraging in the first quarter of 2018 and we expect growth to accelerate as the year progresses,” it said. “Meanwhile, industrial and retail rents have shown signs of bottoming out, but tenants are still largely cautious on their expansion plans.”