· The forward price-to-book ratio of the FTSE ST REIT Index is currently close to two standard deviations below its ten-year average, seemingly cheap. However, we should not take this information at face value and dive straight in.
· In light of the higher for longer rates environment, we stress tested the top ten S-REITs by market capitalisation, addressing the potential downside risks by accounting for cap rate expansion and refinancing risks.
· Certain S-REITs namely CapitaLand Ascendas REIT and Mapletree Industrial Trust, emerged much more resilient than others in terms of available buffers and interest coverage ratios.
· Both S-REITs have continued to show positive rental reversions and possess property types that we believe could benefit from secular growth trends.
· Overall, we advise investors to remain selective in this sector and consider S-REITs that are more resilient in the face of a higher for longer rates environment.
With the forward price-to-book ratio (P/B) of FTSE ST REIT Index hitting 0.84X, close to two standard deviations below its ten-year average (Figure 1), investors may be eyeing this as an opportune moment to enter the S-REIT market. However, we caution investors against hasty decisions and to exercise prudence before entering.
Figure 1: The forward price-to-book ratio of the benchmark for S-REITs has fallen almost two standard deviations below its ten-year average
In our previous update, we stress tested the top ten S-REITs by market capitalisation and advised investors to remain selective in this sector. We also shared possible implications that could befall on these S-REITs should they exceed the MAS regulatory leverage limit.
Related article: Be selective in S-REITs as rates stay higher for longer
Since then, two more S-REITs have joined Manulife US REIT (SGX:BTOU) in suspending their distribution policy as a proactive measure to manage their gearing levels. These two S-REITs namely, Prime US REIT (SGX:OXMU) and Keppel Pacific Oak US REIT (SGX:CMOU), did not exceed the MAS regulatory leverage limit but are inching closer to the 50% regulatory leverage limit with a reported leverage of 48.4% and 43.2% respectively as of 31 December 2023.
Related article: US office S-REITs in shambles
In this update, we share the year-on-year (YoY) change in the distribution of the top ten S-REITs by market capitalisation, findings from our stress test based on their latest full-year results and highlight certain S-REITs that are more resilient than the rest.
What has happened since our last update on this sector?
Based on our stress test conducted on the top ten S-REITs by market capitalisation in November last year, we cautioned investors to avoid MapleTree Pan Asia Commercial Trust (SGX:N2IU), CapitaLand Ascott Trust (SGX:HMN), Keppel REIT (SGX:K71U) and Suntec REIT (SGX:T82U). On the flipside, we also showed preference for CapitaLand Ascendas REIT (SGX:A17U) and Mapletree Industrial Trust (SGX:ME8U) as they have shown greater resilience in our stress test.
Table 1: Top ten S-REITs by market capitalisation
|
Top ten S-REIT by market capitalisation |
Market cap (SGD millions) |
Industry |
Key market(s) |
|
CapitaLand Integrated Commercial Trust (CICT) |
13,267 |
Diversified |
Singapore |
|
CapitaLand Ascendas REIT (CLAR) |
11,335 |
Industrials |
Singapore, Australia, US, UK and Europe |
|
Mapletree Logistics Trust (MLT) |
6,601 |
Industrials |
Singapore, Hong Kong, China, Japan, South Korea and Australia |
|
Mapletree Pan Asia Commercial Trust (MPACT) |
6,466 |
Diversified |
Singapore, Hong Kong, China and Japan |
|
Mapletree Industrial Trust (MINT) |
6,181 |
Industrials |
Singapore, US and Asia |
|
Frasers Centrepoint Trust (FCT) |
3,927 |
Retail |
Singapore |
|
Frasers Logistics and Commercial Trust (FLCT) |
3,626 |
Diversified |
Singapore, Australia, UK and Europe |
|
CapitaLand Ascott Trust (CLAS) |
3,388 |
Hospitality |
Singapore, Australia, China, France and Japan |
|
Keppel REIT (KREIT) |
3,245 |
Office |
Singapore, Australia and South Korea |
|
Suntec REIT (SUN) |
3,117 |
Diversified |
Singapore, Australia and UK |
|
Note: Industry and key markets are based on latest full-year FY2023 company annual reports. The S-REITs have varying fiscal periods, Financial years of FCT and FLCT end in Sept 2023; CICT, CLAR, CLAS, KREIT and SUN end in Dec 2023; MLT, MPACT and MINT end in Mar 2024. Key markets refer to countries that contribute at least 5% of the company’s gross revenue. Source: Bloomberg Finance L.P., REIT Association of Singapore, iFAST Compilations. Data as of 11 June 2024 |
|||
Looking at their latest full-year results, we note that Suntec REIT had the largest distribution per unit (DPU) drop of 19.69% YoY among the top ten S-REITs by market capitalisation. The substantial decline in DPU is largely due to a 46.1% YoY drop in interest income, an uptick of 15.4% YoY in financing costs (FY2023 all-in financing cost: 3.84% p.a. vs FY2022 all-in financing cost: 2.94% p.a.) and an increase of 34.1% YoY in higher property expenses.
Meanwhile, Mapletree Pan Asia Commercial Trust and Keppel REIT also saw a drop in DPU of 7.28% and 2.03% respectively.
On the other hand, CapitaLand Ascott Trust experienced an increase of 15.87% YoY in DPU due to accretive acquisitions and the recovery of the tourism sector. However, this DPU growth is smaller relative to other hospitality S-REITs with greater exposure to Singapore such as Far East Hospitality Trust (SGX: Q5T) and Frasers Hospitality Trust (SGX: ACV) which saw an increase of 25.08% YoY and 49.35% YoY in DPU respectively.
Beyond these four S-REITs, we have also highlighted to investors to exercise caution when investing in Frasers Logistics and Commercial Trust (SGX:BUOU) due to potential refinancing risks. The REIT has seen a drop of 7.61% YoY in its DPU in FY2023.
As for our preferred S-REITs namely CapitaLand Ascendas REIT and Mapletree Industrial Trust, both have shown a relatively smaller drop in DPU of 4.04% YoY and 1.03% YoY respectively. We think this relative DPU stability highlights their resilience.
Figure 2: Suntec REIT had the largest drop in DPU of close to 20% YoY in FY2023
Higher capitalisation rates to dilute property values and increase leverage
We anticipate no Fed rate cuts this year which may suggest further downside risks for S-REITs. Our view of no Fed rate cuts comes from the resilient US economy and the uncertainties surrounding the Red Sea which could potentially drive up shipping and freight costs, and in turn, contribute to sustained inflationary pressures. In the longer term, we expect rates to remain higher for longer, indicating that the era of cheap borrowing rates may have already ended.
Related article: As we predicted, interest rate cuts are looking less likely. Here’s why
Related article: The Fed will not cut rates this year. Here’s why.
To illustrate the potential downside risks of higher for longer rates, we first looked into the impact of a 1% increase in capitalisation rates on property values. We found that a 1% expansion in cap rates will result in property valuations falling by an average of 19%.
Similar to our last update, we note that Mapletree Industrial Trust and Capitaland Ascendas REIT are less vulnerable to cap rate expansion. On the other hand, a greater impact on property valuations was seen in Keppel REIT due to its lower existing implied cap rate.
Figure 3: Some would face a much larger drop in property valuation
A lower value of assets will automatically increase a REIT’s leverage. Thus, we computed the adjusted property values and then calculated the amount of buffer available for these REITs before they exceed their corresponding regulatory gearing limit.
Figure 4: Some have limited buffers in property values after cap rate expansion of 100 bps
We note that the average available buffer stands at 5%, slightly higher than the buffer of 4% in our last update. With that said, Frasers Logistics & Commercial Trust would have the largest buffer of 18%, largely attributed to the fact that it has the lowest reported leverage of 30.2% (as of FY2023) relative to the average peer gearing ratio of 38.5%.
On the flip side, MapleTree Pan Asia Commercial Trust, Keppel REIT and Suntec REIT would have no buffer due to their high gearing ratio of 40.5%, 38.9% and 42.8% as of FY2023 respectively. Moreover, Suntec REIT is currently subjected to a gearing limit of 45% instead of 50% (unlike the other nine) due to its interest coverage ratio being less than 2.5X.
On the next layer of our stress test, we look to capture the downside potential involving refinancing risks.
Refinancing risks persist, dragging down interest coverage ratios
In this layer of stress test, we estimate S-REITs’ new cost of debt in accordance with the prevailing high interest rate environment. We compute the cost of debt after refinancing in 2025, with interest rates based on a credit spread over the MAS Singapore Overnight Rate (SORA).
As of 30th June 2024, SORA was at 3.43%, lower than last year’s average of 3.71% but still about two standard deviations above its ten-year average of 1.26%. With rates now in a much higher territory compared to historical levels and our expectations for rates to stay higher for longer, we expect S-REITs to still face refinancing risks for its near-term debt.
Figure 5: June’s SORA is about two standard deviations above its ten-year average of 1.26%
Through our analysis, we find that some S-REITs who locked in a low cost of debt a few years ago and have a huge proportion of their debt maturing in the next two years would face the greatest refinancing risks. These include Frasers Logistics & Commercial Trust, Capitaland Ascott Trust and Keppel REIT, which would see an increase of over 30% in their cost of debt.
Figure 6: Higher cost of debt estimated after accounting for refinancing risks
Thereafter, we estimate the higher interest expense that will be incurred, assuming that no new debt would be taken on. It is worth highlighting that higher interest expense lowers the interest coverage ratio (ICR).
It is crucial to look into the ICR as it determines which leverage threshold a REIT would be subjected to. On 16 April 2020, MAS announced that it would raise with immediate effect the leverage limit for S-REITs from 45% to 50%, to provide S-REITs greater flexibility to manage their capital structure amid the challenging environment created by the COVID-19 pandemic. MAS also proposed to require S-REITs to have a minimum ICR of 2.5 times (X) before they are allowed to increase their leverage to beyond the prevailing 45% limit (up to 50%).
As previously mentioned, we note that Suntec REIT is currently subjected to a limit of 45% due to its ICR of 2.0X (as of FY2023). Our findings have also shown that some S-REITs would see their ICR fall near the threshold of 2.5X because of higher interest expenses. They are Mapletree Pan Asia Commercial Trust, Capitaland Ascott Trust and Keppel REIT.
Figure 7: After accounting for potential refinancing risks, a few S-REITs are estimated to hover near an ICR of 2.5X
Continued preference for S-REITs that are less challenged
We continue to show preference for CapitaLand Ascendas REIT and Mapletree Industrial Trust which have exhibited greater resiliency in our stress test. As of 31 March 2024, CapitaLand Ascendas REIT’s portfolio by asset value is made up of 46% business space, 25% logistics, 20% in industrials and 9% in data centres. Mapletree Industrial Trust’s portfolio consists of 55% in data centres, 39% in industrials and 6% in business park assets. Both S-REITs are classified as Industrial REITs (Table 1).
The rental market of Singapore industrial properties recorded strong gains in 1Q2024, largely led by warehouses due to favourable demand and supply dynamics. CapitaLand Ascendas REIT achieved rental reversions of 62.0% and 5.8% for its both logistics properties and business park assets in Singapore respectively, contributing to an overall portfolio rental reversion of 16.9% in 1Q24. Meanwhile, Mapletree Industrial Trust also saw positive rental reversion across all property segments from January to March this year and had a portfolio weighted average rental reversion of 6.6% for renewal leases. Moreover, Mapletree Industrial Trust saw an increase of 2.22% YoY in NPI and 0.90% YoY increase in DPU in the same period as well.
Figure 8: Industrial rent is generally on an uptrend
While growth in the industrial property market is expected to slow down amid geopolitical uncertainties which could disrupt supply chains and an increase in supply, secular growth trends from elevated e-commerce penetration and supply chain diversification (e.g China Plus One) are likely to sustain demand and provide resilience for the logistics segment.
Related article: CapitaLand Ascendas REIT: A shelter from the SREIT storm
Meanwhile, Mapletree Industrial Trust has a substantial data centre portfolio, with most of them located in the US (86%), Japan (8%) and Singapore (6%) (as of 31 March 2024). With the US at the forefront of innovation, data centres there benefit from secular growth trends - digitalisation and artificial intelligence.
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Aside from the rosy longer-term fundamentals, we note that Mapletree Industrial Trust has more stable and predictable cashflows.
To start off, data centres consume substantial amounts of energy, exposing DC REITs to potential increases in energy costs. Hence, DC REITs that can pass on higher utility expenses to customers, or whose customers procure electricity directly from power suppliers, should demonstrate greater resilience. A way to mitigate the impact of higher utility expenses is through the adoption of a triple net lease structure which allows the landlord to pass on the risk of paying for utilities, insurance and taxes to their tenants, thereby, mitigating the impact of utility expenses.
About 76% of Mapletree Industrial Trust’s tenants are on triple net lease structure, which is much higher relative to Digital Core REIT (SGX: DCRU) 39% (as of 31 March 2024). Generally, tenants under triple net lease structure tend to have longer lease terms which could lengthen the REIT’s weighted average lease expiry and in turn, increase cash flow stability.
As of 31 March 2024, Mapletree Industrial Trust had a weighted average lease expiry (WALE) by gross rental income of 5.5 years for its US data centres, which is longer than Digital Core REIT’s overall WALE of 2.8 years by annualised rent.
Hence, Mapletree Industrial Trust could benefit from a more consistent and reliable source of cash flows, which further highlights its resilience.
Conclusion: Stay selective in this sector
In summary, based on our stress test, we find CapitaLand Ascendas REIT and Mapletree Industrial Trust to be more resilient in the face of higher for longer rates environment. Also, continued positive rental reversions in its portfolio would also highlight their portfolio quality. On the other hand, investors should exercise caution while investing in Mapletree Pan Asia Commercial Trust, CapitaLand Ascott Trust, Keppel REIT and Suntec REIT.
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