S-REITs recorded one of their best months ever with a 9% rally in December 2023, extending from a near 7% gains recorded in November 2023.
The strong performance in the last two months of 2023 was off the back of actions taken by the Federal Reserve, which held rates steady and indicated three rate cuts in 2024. This provided investors with the confidence to buy REITs as they started to believe that interest rates had peaked, leading to a decrease in the interest burden on REITs and a return of positive business sentiments.
Looking at the broader REIT index’s performance in January 2024 up to 26th January, we see that the iEdge S-REIT index has fallen from 1138 points to 1080 points, a 5.1% decline.
This is still 12% higher than the 52-week low recorded at the end of October 2023 but 13% lower than the 52-week high recorded in February 2023.
Here we look at 4 reasons why S-REITS are dropping again.
1) Interest rates
A strong US economy and pushback from central bank officials are leading some investors to rethink their bets on how quickly the Federal Reserve will cut rates this year, a shift that is rippling through Treasury and foreign exchange markets.
Just a few days ago, federal funds futures pricing for the first rate cut shifted to May, after markets had initially given a 90% chance of a move in March. This change occurred as most recent data and comments from Fed officials’ cooled expectations of a early rate cut.
Economists expect that the U.S. Federal Reserve will wait until the second quarter before cutting interest rates, with June seen as more likely than May and less easing forecast this year than markets now expect.
A delayed rate cut also slows and tapers the trajectory of the rate cut cycle which means that interest rates would remain higher for longer.
2) Exchange rates and Valuations
Most S-REITS have acquired assets overseas due to the limited opportunities in Singapore and for diversification.
In 2023, the SGD did not move much against the USD, EUR and GBP. However it appreciated nearly 10% against the MYR and JPY. This appreciation followed the SGD’s strong performance in 2021 and 2022 against all currencies mentioned above, except for the USD, which has been the strongest performer among the G7 currencies.
A stronger SGD means that the overseas assets are worth less when converted to SGD. Accordingly, the income generated by these overseas assets has also devalued due to the exchange rates. While there could be income hedges in place, these hedges expire over time and serve only to stem the decline rather than reverse them.
Valuations have also either held steady or declined due to higher capitalisation rates arising from higher interest rates. The capitalisation rate (also known as cap rate) is used in the world of commercial real estate to indicate the expected rate of return on a real estate investment property.
When interest rates are higher, capitalisation rates rise accordingly, as the rate of return for an investment property which comes with risks, is expected to be inherently higher than the risk free interest rate.
3) Business performance
The overall business performance of the S-REIT sector has been lacklustre and some segments of the industry have not been able to recover to pre-COVID levels, either due to a change in business dynamics or due to an inflationary environment.
Office REITs have faced challenges due to the new work-from-home (WFH) trends. While companies are gradually increasing the number of days employees spend in office, the hybrid workforce is likely here to stay for at least the near future.
Suntec REIT (SGX: T82U) reported a FY23 DPU that was nearly 20% lower YoY. This decline can be attributed to a 8.3% increase in gross revenue, offset by a 34% increase in property expenses and a 37% increase in finance costs. The REIT has indicated that it is looking to divest its mature assets and Strata units at Suntec City Office to lower its gearing and would likely look to recycle its capital to deliver long-term value.
Retail REITs are not seeing as many tourists post-COVID as tourists from some regions such as China are not travelling internationally as much. The absence of Chinese tourists has been keenly felt in South-east Asia, where for many countries, China had once been their largest source of visitor arrivals.
On a positive note, Singapore’s suburban mall segment remains strong. Frasers Centrepoint Trust (SGX: J69U) released its 1Q24 business update which showed that its committed occupancy stood at 99.9%, as shopper traffic increased by 3.1% YoY. Excluding tenants under renovation, its tenant sales also grew 1.1% YoY. The REIT capitalised on the favourable Singapore suburban mall market by acquiring another 24.5% stake in NEX through a quick private placement, which was 2.5 times subscribed, raising $200 million in the process.
Industrial REITs which include logistics and warehousing assets have seen lower occupancies in parts of their portfolio due to slow economic growth and a global supply chain that is being reworked as companies diversify.
Mapletree Logistics Trust (SGX: M44U) saw share price falling by 5% after its 3Q24 results was announced. Although DPU increased 1.2% YoY, occupancy declined from 96.9% in the previous quarter to 95.9%. Its China portfolio also registered a negative rental reversion of -9.4%.
Hospitality REITs are facing similar challenges to retail REITs due to the decline in tourist and business travellers post-COVID. While Singapore has taken steps to boost tourist arrivals by hosting events and concerts, many Hospitality REITs own properties in the region which may not have been as fortunate. This could soon change as China has just implemented a mutual visa exemption policy with Singapore. Starting from 9 February, Chinese and Singaporean citizens can enter each other’s countries visa-free for stays of up to 30 days.
Specialised REITs include Data Centre REITs. Data Centre is a sector with positive long term tailwinds but has seen near-term fundamentals weaken as tech companies slow their expansion and reduced their capital expenditure plans.
Keppel DC REIT (SGX: AJBU) was a beneficiary of the structural long term tailwinds, growing its asset under management (AUM) from $1 billion in 2014 to $3.7 billion in 2023. In its FY23 results, it recorded stable gross revenue due to acquisitions, positive rental reversions and in-place rental escalations. However it was hit by a loss allowance for uncollected rental income from its Guangdong data centres which reduced its distribution per unit (DPU) by nearly 7%. Without this loss allowance, its DPU would have only decreased by a mere 1.8%, mainly due to higher finance costs and foreign exchange differences.
4) Forward macroeconomic conditions
With inflation cooling, central banks around the world face a Goldilocks dilemma: If they are too easy with monetary policy, inflation could come roaring back; but if they keep policy too tight, it could trigger a recession.
As central bankers try to maneuver a “soft landing,” economists expect their efforts will come with a tradeoff: lackluster growth in 2024 and 2025, especially in developed markets.
Most economists expect that global economic expansion will tick down in 2024 and will be lower than 2023. Depending on the timing of interest rate cuts, 2025 may possibly be a better year than 2024.
Here in Singapore, the economy grew 1.2% in 2023, moderating from the 3.6% growth in 2022, according to advance estimates from the Ministry of Trade and Industry (MTI).
The Government’s growth forecast is for the economy to grow by 1% to 3% in 2024, but much will depend on the external environment which is expected to be less favourable. The Singapore Government typically provides a wider expectation band at the start of the year along with certain caveats and narrows the band through the months.
Closing statements
At this juncture, it depends on whether you take a glass half full or half empty approach.
To put things in perspective, looking at the iEdge S-REIT index again, we note that the index is a mere 12% above 5 year low and 52 week low for the index was at 963 points in Oct 2022 (just slightly higher than levels seen in March 2020 at the worst of the pandemic).
On the other hand, the index is nearly 30% below the 5 year high recorded in February 2020, just before the pandemic caused markets worldwide to crash.
We do caution on taking an overly optimistic approach as it is unlikely for S-REITS to return to their all time highs or even come close, fundamentally due to the current interest rate environment, the structural change in business performance for some segments of REITs as well as the current macroeconomic sentiments.
The interest rate environment have also affected valuations and the exchange rate differentials between countries, affecting the net asset value of REITs and the income being remitted for distribution to unitholders.
At the same time, we do think there are opportunities present to look at REITs who have strengthened their business through strategic acquisitions or asset enhancements, grow their book value and were able to substantially maintain or even increase their distributions to unitholders.
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