Clear and present danger. We expect the current “QE-inflated growth” to run out of steam in the months ahead and S-REIT prices will continue to rationalize. Despite our regional economics’ team’s expectations that QE will persist through 2013, the fact that Bernanke’s mere hint1  of QE tapering on 22 May had driven the S-REITs down by 9.4% by 3 Jun showed how jittery investors have become with yield plays. While some will find S-REITs to be still attractive, we believe fears of impending stimulus withdrawal and rate hikes overhang will cap further upside. Downgrade to Underweight and switch to developers (prefer CapitaLand, Keppel Land, CMA and Wing Tai). For those who must be in S-REITs, we prefer the retail REITS (Suntec REIT, CapitaMall Trust and StarHill Global REIT).

Interest rate risk rising. The SG government ten-year bond went up from 1.56% on 22 May (the day of Bernanke’s Congressional testimony) to 1.86% (30 bps) within a span of five working days, while the DPU yields of S-REITs expanded from 5.1% to 5.7% (60bps). It appears that the market was then pricing in future rate hikes of 30 bps, pending uncertainty over US exit strategy, especially since Bernanke left the door opened to both downward AND upward adjustment depending on how the economy actually does. Another risk could also be the more crowded space amongst S-REITs investors (including private wealth clients), some of whom we understand to have geared up (and thus more susceptible to interest rate hikes) for a “carry trade” on S-REITs. At this writing, the market has since narrowed DPU yields back to 5.6%, ~20bps higher than the 30bps rate hike correction.

Ample QE till September at least but… Our regional economics team believes that current ample liquidity conditions will continue till Sep 2013 at least. They expect QE3 to persist through 2013 and no rate hike in the US before 2015. The Fed is expected to continue its unprecedented USD85 billion a month bond buying (comprising USD40b in mortgage securities and USD45b in treasuries) as long as two key indicators – unemployment and core PCE (personal consumption expenditures) inflation – remain beyond the Fed’s selfimposed tolerance limits of 6.5% and 2% respectively. Nonetheless, given the forward pricing nature of markets, we believe that sporadic corrections for S-REITs are still imminent in 2H13 and take a closer look at trough valuations for FY13.

Volatility will not subside. In this economic climate, we believe SREITs’ trading will get more volatile. In terms of trough valuations, we benchmarked against average yield spreads of S-REITs with the highest FY13 street estimate for SG government ten-year bond of 2.25%. If risk-free rate rises to that level, the downside risk to S-REITs will be a fall in prices down 10% from current levels and most severe for Office REITs (-11%), followed by Industrial (-5%) and then retail (-2%). This assumes negligible DPU growth, which is modest for S-REITs in FY13 (sub-par 7% from 10% in FY12).

No more “perfect” safe haven. We witnessed during the GFC - SREITs’ resilience as an attractive asset class to park funds in the absence of viable alternatives and as long as positive carry is maintained - the recurring distributions compensate investors for any fall in price or/and other expenses. At this nascent stage of global recovery, we believe that some investors will still view S-REITs as a yield play, driven by continued liquidity. However, the impending stimulus withdrawal and rate hikes overhang are likely to cap further upside. Our preference are only for Retail REITs where (1) downside risk to rate hike of 2.25% is lowest (2) FY13 DPU growth is most favorable and (3) the mismatch between rentals and physical prices has also not proved unnerving compared to other sectors. Downgrade to UNDERWEIGHT for the overall S-REITs sector.

Source: Maybank Kim Eng Research - 6 Jun 2013