REITs are a great investment tool given their income generating characteristics and tangible assets backing stock price valuations.
In Singapore, there are now a total of 37 REITs, not counting the soon to be listed REIT that Keppel is bringing to market with US properties.
For those interested in investing in REITs and getting a snapshot of how the market is performing, here are the top 10 most commonly asked questions that Phillip Capital get from retail and institutional investors.
- What is the impact of US rate hikes on REITs? Is it still safe to buy REITs?
- Apart from higher financing costs, in what other ways do higher interest rates affect REITs?
- What is the outlook for the retail, commercial, industrial and hospitality REIT sectors?
- How do Singapore REITs compare with regional REITs?
- Is valuation attractive from a yield angle? How do Singapore REIT valuations stand compared with historical valuations?
- What is an appropriate way to judge if a REIT is over- or under-valued?
- Would investors be better off investing in growth stocks (rather than stable counters like REITs/Telcos/Utilities) if the assumption is global economic growth?
- Is a REIT with more freehold properties better than another with shorter leasehold properties?
- How would you calculate and compare REITs’ metrics and duration vs fixed income in a falling, flat and rising interest rate environment?
- What are the key risks of investing in REITs now?
Singapore REITs have returned 14.2% in the first 9 months of 2017.
It’s the sixth best performing sector within the STI.
The full list as follows.
- IT is the best at 60%
- Materials at 32.7%
- Real estate at 26.9%
- Financials at 19.3%
- Consumer discretionary at 18.9%
- Singapore REITs at 14.2%
- Industrials at 14.2%
- Utilities at 3.1%
- Telecommunication services at 0.2%
- Consumer staples at -0.7%
- Health care at -2.6%
- Energy at -3.3%
Investors have no need to worry about tightening monetary policies and rate hikes if they occur in response to better economic data.
This is compared to tightening monetary policies and rate hikes that respond to supply-side inflation.
The previous rate hike cycle from 2004-2006 saw REITs returning 26.5% vs STI’s 15.9%. See following two figures.
Last rate hike cycle occured in 2004-2006
Singapore REITs performed well during the last rate hike cycle
This suggest REITs can perform well in rising rate environments.
The important point is whether the economic growth is able to drive rental income higher. This would then offset increased borrowings costs.
Strong economic growth driving rents upwards
I personally find it difficult to forecast where long term interest rates will be in future so don’t place too much emphasis on making an investment decision based on the very large macro environment.
Nevertheless, I do keep an eye out for trends and changes in the macro environment, especially as it affects GDP and inflation.
2. Apart from higher financing costs, in what other ways do higher interest rates affect REITs?
Increase in long term interest rates decrease the yield appeal of REITs because of a smaller yield spread (REIT yields – government bond rates) and higher financing costs for REITs.
In terms of financing costs, borrowing costs for REITs have been kept low due to the competitive banking landscape in Singapore.
This is despite the rising Singapore Offer Rates (SOR) over the past 2 years. The Singapore dollar appreciation has also meant the SOR uptick has been muted.
3. What is the outlook for the retail, commercial, industrial and hospitality REIT sectors?
In summary, the office, industrial and hotels sector face a positive scenario with decreasing supply after a peak in 2017.
The retail sector on the other hand is facing increasing supply and competition from online players such as Amazon, Lazada, Qoo10 and Carousell among others.
Retail sector facing increasing supply (blue bars)Retail rents and occupancy have been falling since 2013Office supply (blue bars) will taper off after 2017Office rents and occupancy relatively stable since 2010. Rents and occupancy anticipated to increase.Industrial space supply falling from 2017 peakIndustrial rents and occupancy set to improve after 4 years of decline New hotel supply tapering off. 4% in 2017 then 1.7% and 1.8% over the next 2 years.Hotel RevPAR turning a corner
4. How do Singapore REITs compare with regional REITs?
Singapore REITs trade at the highest yield of 5.9% vs other major REIT markets such as Australia, US, Hong Kong and Japan.
The yield spread is however smaller, behind HK and Japan.
As a recap, a smaller yield spread means REIT valuations may be high in that market. A smaller yield spread means investors also have the alternative of investing in government bonds without missing out on too much.
Singapore REITs offer highest absolute yield of 5.9%
Singapore REIT yield spreads at 3.8%. In line with average.Australia REITs yield spread at 2.3%, close to +1 s.d. Suggests value.US REIT yield spreads at 1.8%, close to +1 s.d. Suggests value.Hong Kong yield spreads at 4.2%, below post-GFC spreads. Suggest full pricing.Japan REIT yield spreads at 3.9%, above post-GFC average. Suggest value.
For Singapore investors, it may be wiser to stick to the local market despite the lower yield spreads. Venturing overseas exposes one to foreign currency risk, and it is harder to obtain information on the REIT that is listed overseas.
I personally would stick to the local market until I have enough spare cash to diversify overseas. Most of my expenditure are also in Singapore dollars so there is a natural hedge between the REIT dividends and expenses.
5. Is valuation attractive from a yield angle? How do Singapore REIT valuations stand compared with historical valuations?
Singapore REITs presently trade at a yield spread of 3.8%.
This is calculated at Singapore REITs average yield of 5.9% – risk free rate of 2.1%.
This is around the post-GFC period (2010 to present).
Valuation is fair and not deviating too far from historical values.
While yield spreads are an important indicator to consider when investing in REITs, I personally consider it a second order indicator behind the absolute yield of REITs. This is because I am firstly an income investor and the yield itself is the main thing I am chasing after.
Another reason is that there are two moving parts in the equation, the REIT’s yield and long term government bond yields.
Long term government bond yields are difficult to predict and they have been in a secular 30 year bull market. How this moves will be anyone’s guess.
However, there is value in looking at how tight or wide the spread is. When it goes to extremes, it may be a time to pay attention. However, when it is close to historical averages, it may not provide too much information for an investor.
6. What is an appropriate way to judge if a REIT is over- or under-valued?
Price to NAV is one metric to ascertain REIT valuation. It will be useful to look across the industry, peers and a REIT’s own historical price to NAV value.
Typically, big cap REITs trade at higher valuations than smaller REITs.
For example, Mapletree Industrial, a big cap REIT, has traded at an average price to NAV of 1.23 post the GFC.
One reason for the price to NAV premium of big cap REITs is their ability to obtain lower costs of funding, making it easier for accretive acquisitions.
They also enjoy economies of scale in the management of a larger portfolio.
So one way of using the price to NAV ratio is to compare that of big cap REITs with other similar sized market cap REITs.
When comparing a REIT’s price to NAV with its own historical vales, an eye should be kept on the macro environment to see if the environment can justify it trading at a premium/discount.
If a REIT’s price is trading at a large discount to book value, the market may be pricing in potential deterioration of the portfolio. A large discount to book value does not immediately indicate a value buy.
Here is a list of Singapore REITs ranked by their dividend yield and price to book ratios.
7. Would investors be better off investing in growth stocks (rather than stable counters like REITs/Telcos/Utilities) if the assumption is global economic growth?
Unlike telcos and utilities where fees and tariffs are highly regulated, REITs are exposed to commercial rents and prices which are market driven.
As a result, REITs are able to capture upside in rents in an improving economy, and at the same time pay out at least 90% of rental income.
This would appeal to investors desiring passive income and give them exposure to growth in improving economies.
8. Is a REIT with more freehold properties better than another with shorter leasehold properties?
Land tenure is but one consideration to look at while determining the value of a REIT.
It is insufficient to conclude if the portfolio is better or worse off than another.
Typically, when comparing two like-for-like properties in the same vicinity with one being freehold and the other leasehold, the freehold property will trade at a lower cap rate, or higher valuation.
The NAV of the REIT would already price in the freehold factor.
Another example of REITs pricing in properties with shorter land tenures is that of industrial ones. One reason industrial REITs trade at higher yields is the fact that industrial properties in Singapore tend to have shorter 30 year leases compared to retail and office properties.
The higher yield compensates investors for the shorter tenure and lower capital gain potential.
9. How would you calculate and compare REITs’ metrics and duration vs fixed income in a falling, flat and rising interest rate environment?
Unlike fixed income instruments, REITs do not have fixed maturities, making the calculation of duration difficult.
An easier metric for investors to watch out for is the sensitivity of earnings to fluctuations to interest rate or forex movements.
This section can usually be found in an annual report’s “sensitivity analysis”.
10. What is the key risk of investing in REITs now?
Accelerating inflation could lead to faster than expected rate hikes or monetary tightening by the Fed. This is the largest risk due to inflation impacting rents, and borrowing costs impacting financing costs of REITs.