• Expecting rise in interest rates
• Focus on fundamentals and growth
• Suntec, SGREIT and FCT as top picks

Selecting the winners

The S-REITs sector has rallied 7.3% and outperformed STI by 4ppt YTD on US Fed Chair Janet Yellen’s forward guidance that interest rates are likely to stay low “for a considerable time”. However, against this backdrop, we note that the Fed will continue to cut the bond purchases meant to suppress the long-term borrowing costs low, keeping it on track to end the stimulus programme late this year. Even the recent forecasts by the Fed officials point to a possibility that the interest rates may rise faster than previously expected. Given these developments, we now make a conscious effort to select the SREITs that are likely able to withstand any potential correction better and outperform the rest.

Fundamentals still sound

Our findings show that the fundamentals of S-REITs have generally remained sound, and S-REITs continue to benefit from their past investments and higher secured rentals within their existing portfolios. On a relative basis, the office REIT subsector outlook looks the rosiest, as the uptrend in office rents is likely to be sustained amid strong leasing activity, low vacancy and limited supply in the near term. This is followed by retail REITs, which are poised to reap the returns of their AEIs and the positive operating landscape. For FY15, we note that Suntec REIT and CapitaCommercial Trust are expected to experience one of the fastest increases in DPU, according to Bloomberg consensus forecasts.

Assessing impact from interest rate hike

On the capital management front, S-REITs have again stepped up their efforts to repay/refinance their borrowings ahead of their maturities and over a longer term, as well as hedge their interest rate exposure in anticipation of the potential hike in interest rates. This has resulted in an improvement in gearing, debt duration and hedge ratio. In fact, for a 1ppt growth in interest rate, we estimate the greatest fall in DPU among the S-REITs is contained within 10%, while several S-REITs such as Starhill Global REIT are likely to be unscathed as a result of fixing 100% of their rates via hedges or fixed-rate notes.

Our sector picks

In view of all this, we retain Suntec REIT [BUY, S$1.85 FV] and Starhill Global REIT [BUY, S$0.90 FV] as our sector picks. CapitaCommercial Trust, our third preferred pick, has performed very well YTD, clocking a 15.9% increase in unit price. At current level, we believe most of the positives have been priced in. As such, we replace CapitaCommercial Trust with Frasers Centrepoint Trust [BUY, S$2.08 FV] as our preferred pick. The latter has a strong financial position, trades at an attractive yield of 6.1% and P/B of 1.06x and is expected to see relatively robust earnings growth over the next year. Retain NEUTRAL on broader S-REITs sector.

Source: OCBC Research - 30 Jun 2014