• Expect headwinds to persist
• Position for bargain hunting opportunities
• FCT, KDCREIT, AREIT, FLT, MGCCT our top picks

DPU performance YTD largely muted

Looking back at the financial performance of the S-REITs sector YTD, we see a common trend of a moderation in DPU growth, with some REITs even recording negative growth for 9MCY16. The key factors driving the softer performance can be attributed to slowing rental reversions, higher operating costs and dilution arising from equity fund raising exercises and issuance of units as payment for management fees.

Within our SREITs sector coverage, overall DPU growth for 9MCY16 came in at -0.4% on a YoY basis. If we take into account significant one-off items, adjusted DPU would instead have declined by 0.5% YoY, based on our estimates.

Operational headwinds likely to persist in 2017

We believe unfavourable demand and supply dynamics across the various sub-sectors are likely to persist in 2017. Coupled with sluggishness in the macroeconomic environment, headwinds would continue to impact the performance of S-REITs, in our opinion. However, this would be partially buffered by rental leases which have been locked in with tenants for a period of time, thus providing some resilience to the income streams of REITs. In addition, we believe REIT managers have also adopted prudent measures to manage their interest rate and FX risks.

Focus will be on number of rate hikes next year

In our view, a rate hike during the Dec FOMC meeting appears to be a foregone conclusion, drawing reference from the fed funds futures rate. The probability of this happening now stands at 100%. The key question on investors’ minds would be the pace of normalisation in interest rates in 2017, and this has been compounded by uncertainties raised after Donald Trump’s victory in the U.S. presidential elections.

Although there are concerns that his expansionary fiscal policy plans may result in interest rates rising faster than previously anticipated, it remains to be seen how aggressively he would push through these policies, while it would also take time to implement the stimulus measures and for the effects to be felt.

Valuations not demanding; maintain OVERWEIGHT

Given the recent volatility in sovereign bond yields, the FTSE ST REITs Index (FSTREI) is trading at a forward yield spread of 428 bps against the Singapore Government 10-year bond yield, which is slightly below the 5-year average of 440 bps. However, with continued vagaries in the geopolitical and macro landscape, we believe good quality defensive yield assets should still warrant a strategic position in investors’ portfolio.

We opine that valuations are not demanding, and maintain OVERWEIGHT on the S-REITs sector. The year ahead is likely to remain volatile, and we believe investors should be nimble and position themselves for bargain hunting opportunities when the sector experiences a pullback.

Our preferred sector picks are Frasers Centrepoint Trust [BUY; FV: S$2.33], Keppel DC REIT [BUY; FV: S$1.35], Ascendas REIT [BUY; FV: S$2.67], Frasers Logistics & Industrial Trust [BUY; FV: S$1.10] and Mapletree Greater China Commercial Trust [BUY; FV: S$1.15].

Source: OCBC Research - 7 Dec 2016