In Focus

Is the worst over for S-REITS?

After a 7% dip on rising bond yield fears, the bulls remain optimistic.

Back in 2013 S-REIT prices tumbled by 22% so its natural investors are asking whether this is a repeat of history. DBS analyst Derek Tan noted that at the end of 2017, with the return of growth led by the office and hospitality sectors due to a recovery in spot office rents and hotel room rates, yield spreads would tighten to 3% using a normalised 10-year bond yield of 2.5-2.6%.

“Due to the stronger-than-expected GDP growth numbers, normalised yield spreads for the S-REITs did tighten towards 3-3.1% in early January (3.4% spot yield spread using spot 10- year bond of 2.1%). Following the recent spike in both the US and Singapore 10-year bond yield to 2.9% and 2.3% respectively on fears over the return of inflation and the US Federal Reserve increasing interests rates at a faster pace, investors took the opportunity to lock in profits with the normalised yield spread increasing to 3.3% (using our DBS economists' revised Singapore 10-year bond yield of 2.7% by year-end) and the spot yield spread (using spot Singapore 10- year bond yield of 2.3%) blowing out to 3.7% which is close to the historical average yield spread of 3.8%,” he noted.

In contrast, today the market is jittery over faster-than-expected growth causing a return of inflation, resulting in the US Federal Reserve being more hawkish. “However, we should note that if the interest rates go higher, hitting our DBS economists’ projections of 3% and 2.7% for the US and Singapore 10-year bond yield by year-end, the percentage increase in interest rates and impact would be less as we are now starting at a higher base compared to the taper tantrums in 2013."

"In 2013, the US 10-year bond yield stood around 1.92% at the start of the SREIT market correction before ending at 2.88% when the S-REIT index hit its lows. This is a 50% increase in the long bond yield as compared to a potential 20% increase from 2.56% in early January 2018 to 3% by year-end,” he noted.

But S-REIT investors also need to look at the outlook for rental income. “Looking ahead, we see upside in distributions, driven by firmer underlying property fundamentals. Unlike 2013, the forward picture in 2018-2019 for most property sectors remain positive, driven by stronger economic activity and a supply squeeze (especially in the office, hotel, warehouse and business park sectors), will mean a multi-year recovery in rentals,” he added.

“Whilst we are confident that we already approaching the lows, we have also conducted a bear case scenario analysis to gauge which stock has already been oversold. Whilst there is a potential decline in share prices for several S-REITs based on our bear case analysis, in our view using the average yield spread during the 2013 taper tantrums does not reflect the different economic environment nor the stage of the property cycle we are currently in."

"The more accurate yield spread we believe investors should use is closer to what was achieved during the up-cycle in 2006-2007, which proves for upside potential to the current share prices of various S-REITs.”

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