Even though rate hikes have been priced in, whenever the US Federal Reserve (Fed) announces a rate hike, the very next trading day, REITs listed in Singapore will likely have a down day.
This time is no different.
Last week (14 Dec), the Fed announced a 50 bps hike to 4.5%, the highest level in 15 years and a revised guided terminal rate of 5.1% by 2023 up from 4.6% in September. Not only does higher interest rates dampen economic sentiments, it also directly affects REITs with higher financing cost.
To make things worse, the forecasted real GDP has been revised down to 0.5% from 1.2% in September’s projection for 2023. The range of expectation is from -0.5% to 1% which means that some of the Fed Board members are expecting a recession. A forecasted GDP growth of 0.5% may also imply a few quarters of negative growth, which is a recession by definition. Poorer economic performance also weighs on the operating performance of a REIT, affecting its revenue as the REIT could see lower occupany rates and even negative rental reversions.
Here we look at 3 S-REITs that have underperformed this week and understand what happened to these REITs.
| S-REIT | Ticker (SGX) | 1 week return (%) | 3 month return (%) | YTD return (%) | Market cap (mil) | P/B ratio (times) | Gearing Ratio (%) | Dividend yield (TTM) (%) |
| Manulife US REIT (MUST) | BTOU | -9.7 | -13.3 | -51.5 | US$561 | 0.46 | 42.5 | 16.0 |
| Keppel Pacific Oak REIT (KORE) | CMOU | -11.9 | -26.7 | -40.0 | US$506 | 0.58 | 37.5 | 12.4 |
| OUE Commercial REIT (OUECT) | TS0U | -5.6 | -9.5 | -23.9 | S$1800 | 0.6 | 39.1 | 6.4 |
1) Manulife US REIT (MUST)
While not the worst performer this week, MUST is the worst performer of this year so far. As a US centric REIT, MUST’s performance is largely determined by the US property market where tenants are down sizing and rental reversions are weak. Looking at the chart below, MUST’s YTD rental reversion is +1.7% and with a large portion of their lease expiring in 2027 and beyond with an average annual rent escalation of only 2.2%, the REIT is locked in amidst a high inflationary environment.
MUST is actually well hedged against the current interest rate volatility with 81.1% of fixed rate debt. However, we note that, although not mentioned in their slides, when we attended MUST’s analyst brief, the management explained that the debt that are unhedged mainly relates to the 2027 maturity tranches. This would mean that should interest rate remain elevated through 2023 across the yield curve, MUST would likely see their fixed rate debt portion decline through expiries and the REIT would probably not hedge its 2027 debt tranches at high interest rates.
MUST’s top priority is to manage its relatively high gearing, carrying out a strategic review, assessing its future business directions and considering strategic partnerships or mergers and acquisitions. We think perhaps the market has been spooked by this term as MUST’s share price has fallen by more than 15% in the past 1 month. We note that some companies that has carried out strategic reviews in the past include names such as Starhill Global REIT (formerly MMP REIT), SPH, Eagle Hospitality Trust, Keppel Corp and SembCorp and some(but not all) of them have turned out positively.
MUST is also revitalising its existing assets through a repositioning, turning its Peachtree asset into a hotelised office in 1H23 and Plaza asset into a flexible space solution in 3Q22. Although this repositioning a little late as compared to other real estate companies who embarked on this transformation during COVID, one may say that it is never too late to do so. The hotelised office concept refers to a set up that not only has traditional office spaces but also conference/event spaces, flexible spaces, rooftop bar/gardens, gym, a chill out zone and also a concierge.
2) Keppel Pacific Oak REIT (KORE)
Given the poor macroeconomic conditions in the US property market and the high interest rate environment, it is probably no surprise that the second stock on the list is also a US centric REIT.
KORE has similarly underperformed this week, although rental reversions are slightly higher than MUST at 2.9% for the year and 5.3% for the quarter. Built in average annual rental escalation is at 2.5% across its portfolio.
KORE has a fixed debt ratio of 76.8%, slightly lower than MUST but also a lower current interest rate cost of 3.1%. KORE has also refinanced its 2023 debt with the next tranche of debt due to mature only in 4Q2024.
Despite the weak macroeconomic conditions, looking at the chart below, KORE is projecting a reasonable 2.3% growth in rent for its key growth markets. The REIT has also highlighted that a portion of its portfolio has rents that are currently 5% below asking rents which would provide its assets with an avenue for organic growth.
3) OUE Commercial REIT (OUECT)
OUECT is the 3rd weakest this week, declining by 5.6%. The REIT was formed in September 2019 with the merger of OUE Commercial REIT with OUE Hospitality Trust and the share price has been on a downtrend since.
Looking at its most recent 3Q22’s performance, each segment seems to have performed relatively well with increased occupancies and positive rental reversions. The office segment is clearly the star segment of the REIT. The hospitality segment is still recovering, and revenue remained at the minimum rent level under its master lease arrangements. Its retail segment still has not seen shopper traffic and sales recovering to pre-COVID levels, largely due to the location of its retail asset which tends to have a larger proportion of tourist revenues as compared to suburban retail malls.
The outlook ahead for OUECT also seems to be a mixed bag. OUECT expects its Office segment to continue to be resilient with its portfolio of grade A offices despite the global macro headwinds and consolidation in the tech sector. The hospitality segment should see further improvement due to further easing of pandemic measures and pick up in MICE events, however the uncertain economic outlook and inflationary pressures will likely weigh.
OUECT’s believes that rent for Orchard Road, where its retail asset is located has likely bottomed out and are confident that rents can be raised despite low retail confidence. The recovery of the Orchard Road strip will also benefit its hospitality assets.
OUCT also has a stable debt maturity profile with 12% of total debts maturing in September 2023. However its fixed rate debt and Interest coverage Ratio are the lowest among the 3 REITs featured here at 69.2% and 2.7x respectively.
Closing statements
These REITs are down significantly this week and YTD for a reason. While they now provide attractive yields, there is a reason why the share price has declined so much. Of the 3 REITs, it seems like only OUECT has a somewhat positive outlook while investors of MUST & KORE have been spooked by the weak US property market and MUST’s strategic review.
However, OUECT has a low fixed rate debt and somewhat low interest coverage ratio. Should the economy weaken, and interest rates increase further to combat inflation, OUECT may see its debt cost increase and interest coverage ratio decline.
In conclusion, as it does not seem like all 3 S-REITs are out of the woods yet, despite the low valuations, these REITs are probably for the adventurous investors as there is an elevated risk of investing in these REITs.
