• Downgrade to NEUTRAL from Overweight. Amid rising interest rate volatility (likely to persist in the near term), we expect S-REITs’ price performance to be range-bound. We recommend investors stay selective and defensive, rooted on valuations. Our preference remains the industrial sector and REITs with strong balance sheets and sponsor support. Overseas S-REITs, on the other hand, are trading at distress valuations and could see a sharp bounce back once the dust settles. CapitaLand Ascendas REIT, AIMS APAC REIT, and Keppel REIT are our picks.

• US Federal Reserve (US Fed) rate path holds the key. As Singapore adopts monetary policy, its benchmark interest rates are closely correlated to the US’ Federal Funds Rate (FFR). The RHB Economics team’s FFR forecast is for the US Fed to continue hiking in March, with a peak of 5.25- 5.5%, and no cuts in 2023. As S-REITs are considered as yield instruments, its performance is highly sensitive to the interest rate curve. A key sector catalyst would be an earlier-than-anticipated rate cut or pause without significant deterioration in the economic outlook. The converse is a key risk.

• DPU growth to flatten on rising interest cost pressures. For FY23-24F, we expect flattish (average) DPU for stocks under our coverage, with hospitality and industrial S-REITs being key growth drivers. DPU outlook is mainly weighed down by rising borrowing costs, which have risen (sector average) by 60bps since 2H22, and are expected to rise by 75-100bps this year, as the full effect of rate hikes gets transmitted. This is despite S-REITs having a good hedge profile of c.73% of debt. On the other hand, cost pressures have likely peaked, as utility costs – a key contributor to higher expenses last year – have normalised, and most S-REITs have adjusted service charges to offset inflationary pressures.

• Operationally, S-REITs remain resilient. Most S-REITs are guiding for positive rent reversions (low to mid-single digits) to continue in FY23, albeit at a slightly lower pace. High occupancy levels are expected to be maintained for industrial S-REITs. Office and retail S-REITs are likely to see some fluctuation in occupancy levels amid softening demand, but remain well supported by limited supply. Unsurprisingly, Singapore asset values have held steady with slight increases in hospitality, office, and logistics assets. On the other hand, overseas portfolios (particularly the office sector) have seen a drop in value. Looking ahead, we expect a modest cap rate expansion (5-25bps) and do not expect any significant drop in asset value.

• Prefer industrial SREITs; valuations at reasonable entry level for mid- to long-term investors. YTD S-REITs stayed flat (Fig 28) with healthcare and industrial SREITs outperforming. We expect investors to stick to a defensive posture amid increased volatility, while industrial and healthcare REITs continue their outperformance. Overseas, office and retail S-REITs could potentially make a comeback in the second half of the year, upon normalisation of interest rates and a clearer view on the economic outlook.

Source: RHB Research - 20 Mar 2023