The FOMC held the federal funds rate unchanged at 5.25-5.5% for the third straight meeting on 13 Dec 2023 and is now signalling that it expects to make three 25bps rate cuts in 2024. This helped to drive a rally in S-REITs share prices – the S-REITs index gained 8.9% in December. With lower interest rates, S-REITs will experience 1) lower financing costs; 2) higher dividend yield spreads over bonds; and 3) higher property valuations as cap rates compress. Furthermore, with interest rates peaking, we expect deal-making to return in full swing. Therefore, we expect a sector recovery in 2024-2025.
We compiled the list of S-REITs with perpetual bonds and their respective call dates (Figure 3). Given the high interest rate environment, we think some S-REITs which have perpetual bonds with 2024 next call dates may redeem the bonds to save on interest costs, instead of resetting the coupon rate at a higher level.
Elite Commercial REIT (ELITE SP, BUY, TP £0.38) issued 103,354,690 new units through a non-renounceable and fully underwritten Preferential Offering to raise £28.0mn, with 214 units offered for every 1,000 existing units at an issue price of £0.27. £27.0mn (96.4% of gross proceeds) will be used for debt repayment, reducing overall leverage to 43.5% (Dec23: 49.6%), translating to an increase in debt headroom of £55m (50% cap). £1.0mn (c. 3.6% of gross proceeds) will be used to cover fees and expenses. Following the preferential offering, the share base is projected to increase by 21.4%, dragging NAV per share to 0.4 pence (Dec23: 0.43 pence). This strategy was expected to result in pro forma interest expense savings of £1.1mn and an increase in distributable income for 9M23 from £13.6mn to £14.7mn. However, Distribution Per Unit (DPU) was forecast to decrease by 11.3% to 2.5 pence due to the enlarged share base. The overall subscription rate for the Preferential Offering was c.121.2%, and Sunway RE Capital Pte. Ltd increased its unitholding from 5.8% to 11.2%.
We initiated coverage on Far East Hospitality Trust (FEHT SP, BUY, TP S$0.79). With the increase in flight capacity and the anticipated return of Chinese tourism, we believe FEHT’s RevPAR is poised for continued growth. Mega events like the upcoming concerts of Taylor Swift, Coldplay, and Ed Sheeran, along with a packed MICE schedule, including the Singapore Airshow, are expected to significantly contribute to this positive trajectory. We forecast a 4.2% DPU growth in FY24e for FEHT. To counter the impact of high-interest rates, FEHT plans to cushion distributions with the S$18.0mn incentive fee, targeting a FY23e dividend yield of c.6%. FEHT stands out as one of the least leveraged S-REITs, with a 32% leverage ratio and a 3.2% cost of debt. Looking ahead, FEHT is actively pursuing overseas opportunities, particularly in Japan. Focusing on smaller assets averaging S$70mn-80mn each with an expected positive carry of c.2%, this strategic expansion leverages FEHT’s strong debt headroom of around S$900 million (50% gearing).
Nov 23 retail sales index (excluding motor vehicles) grew 1.3% YoY, compared to the 1% decline in Oct 23. Food and Alcohol recorded the highest growth of 13.6%, while watches and jewellery rose 12.9% due to greater demand for jewellery. We think the latter will lead to better tenant sales for downtown malls.
The F&B services index grew 1.4% YoY in Nov 23, extending the 2.4% growth in Oct 23, with food caterers (+12%) experiencing the largest growth. We think retail sales could be strong for Dec 23 as the increase in GST in 2024 might cause consumers to frontload some of their discretionary spending to avoid paying that additional 1% tax.
Singapore’s international visitor arrivals grew 35% YoY in Nov 23 to 1.1mn, but it is still at 28% below pre-COVID Nov 19. The return of Chinese travellers has been slower than expected, and it is at only 42% of pre-Covid levels. We are expecting this to pick up in 2024, supported by the 30-day visa-free entry for Chinese citizens.
RevPAR fell 9.5% YoY in Nov 23, with average daily room rates and occupancy falling 1.8% and 6.7ppts YoY, respectively. Nov 23 numbers suggest that room rates may have peaked as consumers grow more price-conscious. However, with a solid line-up of concerts along with a packed MICE schedule in Singapore, we think RevPAR will return to growth in 1H24, underpinned by the gradual recovery of international visitor arrivals.
OVERWEIGHT on SREITs (Maintained)
After the 8.9% rebound in the S-REITs index in Dec 23, S-REITs are now trading at a forward dividend yield of c.5.8%, 0.4x s.d. below the mean of 6.1% (Figure 5) and a P/NAV of 0.93x, 1.1x s.d. below the mean of 1.03x (Figure 4). Despite the recent rally, we still think it is a good time for investors to reposition into SREITs for the eventual interest rate pause and decline. Although it will remain challenging for S-REITs (apart from the hospitality sub-sector) to grow DPU in 2024, with interest rates peaking and possibly decline, we expect low single-digit DPU growth in FY24.
Due to the recent share price performance, the dividend yield spread has fallen to 3.1%, and it is 1.3x s.d. below the mean of 4% (Figure 2). However, with interest rates expected to fall, the dividend yield spread could widen as the SG10Y yield falls.
Sub-sector preferences: Hospitality and Retail (Unchanged)
We think the hospitality sub-sector will be able to generate the most DPU growth on the back of higher RevPAR and the gradual reopening of China as outbound flight capacity from China increases. Suburban retail offers resilience in a downturn while downtown retail stands to benefit from the recovery of international visitor arrivals, which will in turn lift tenant sales and sentiment.
Retail (OVERWEIGHT). We anticipate tenant sales to rise further due to the increasing number of international visitor arrivals and population growth. The occupancy cost of c.15% for suburban malls and c.25% for downtown malls is lower than historical averages, leaving the potential for more positive rental reversions. There is also very little new supply entering the market. Return to office and a pick-up in major events to be held in Singapore in 2024 should continue to lift tenant sales and give confidence to retailers. Positive rental reversion, ranging from high-single digit to low-teens, is anticipated for downtown malls, supported by the 30-day visa-free entry to Singapore for Chinese citizens. Demand remains robust for catchment areas around suburban malls, and we foresee a healthy mid-single-digit rental reversion continuing into FY24e.
Office (NEUTRAL). We think core CBD Grade A office rents at $11.85 psf pm in 3Q23 will come under pressure as the market absorbs more supply coming in 2024 from IOI Central Boulevard Towers (1.2mn sq ft) and Keppel South Central (600k sq ft). More downsizing could occur as global layoffs among tech firms find their way into Singapore. This could affect office leasing momentum and sentiment, and we therefore anticipate office rents to be muted in FY24. Elsewhere, we expect to see further declines in overseas office property valuations during the FY23 year-end valuations exercise, due to cap rate expansion and weaker operating performance.
Industrial (NEUTRAL). The slowdown in manufacturing and a bleak economic outlook will likely affect industrial property demand. Furthermore, a new supply of 1.9mn sqm is expected to come on stream in 2024, and this is expected to outstrip demand. However, industrial REITs are benefiting from the secular growth of new economy tenants such as tech, life sciences, biomedical, semiconductor and electronics manufacturing, which typically locate themselves in high-spec, science and business parks, and warehouses.
Hospitality (OVERWEIGHT). RevPAR is likely to continue its upward trajectory – but at a slower pace compared to 2023 from the higher base. Also, the increase in MICE and entertainment events in Singapore will further boost this sector. We believe the hospitality sub-sector has the most potential for DPU growth as its increase in revenue can more than offset any rise in interest expenses and operating costs.