At the FOMC meeting on 16 March 2022, the Fed rate was raised by 25bps from 0-0.25% to 0.25-0.5%. The median member of the FOMC expects the Fed fund rate to be 1.9% at end of the year, a total of seven rate hikes in 2022. Looking back at past rate hike cycles in 2013, 2015 and 2017 (Figure 3), we observe a strong inverse correlation between the 2Y-10Y yield curve and the price performance of the SREIT. SREITs have outperformed when yield spreads narrow. We think SREITs could rally, considering 2022-23 rate hike expectations and yield spread compression.
While rising interest rates are a headwind for REITs, SREITs have employed a high interest rate hedge averaging c.72%. Based on sensitivity analysis of SREITs under our coverage (Figure 4), a 100bps increase in interest rates will reduce FY22 DPUs by 0.7-8.6% and 3.7-15.4% on a hedged and unhedged basis, while a 50bps increase in our DDM risk-free rate assumption will reduce our target prices by 0.3-5.0%.
Singapore announced further relaxation of COVID restrictions on 24 March 2022; (1) raising of dine-in and group size from five to 10; (2) resumption of atrium sales; (3) capacity limits raised to 1,000 pax or 75% of venue capacity; (4) sale of alcohol permitted after 10:30pm; and (5) workplace capacity increased from 50% to 70%. Return to office and larger dine-in group sizes should help draw more footfall to malls and uplift tenant sales for both suburban and downtown malls. The Jan22 retail and F&B sales have recovered, coming in 1.8% and 5.9% below Jan19 levels (Figure 10 and 11).
Quarantine-free entry into Singapore for vaccinated travellers will begin on 1 April 2022. Vaccinated travellers are subjected only to a pre-departure test. The removal of quarantine and VTL-designated flight requirements and reduction of COVID-testing requirements is a big step towards rebooting Singapore’s tourism industry. However, we expect the number of hotels booked by the government for isolation purposes, which has benefitted some of the hospitality SREITs, to taper off.
Resident outbound by air outpaced international visitor arrival (IVA) at 11.7% and 4.3% of 2019’s monthly average respectively. Feb22 RevPAR was up 76.8% due to higher occupancy and room rates. Feb22 occupancy was 62.4%, up from 44.7% a year ago, but still 26ppts below Feb19’s 88.5%.
Maintain OVERWEIGHT on SREITs
SREITs have exhibited an inverse correlation with the yield curve, with periods of narrowing yield spread often corresponding with a rally in share prices. We could see REITs rally, supported by recovery of retail, office and hospitality REITs as the world returns to normalcy. The raising of interest rates is intended to keep inflation and growth in check. This may result in a reversal of flows back into REITs as growth stocks looks less attractive on a risk adjusted basis.
Bloomberg consensus forecasts 2022/23 10YSGS yields at 2.0% and 2.3% respectively. We remain overweight on SREITs due to the high levels of interest rate hedging employed, averaging 72%, and portfolio rebalancing and rejuvenation efforts by the REITs during the pandemic years. REITs made $13bn in acquisitions in 2021, entering this phase of recovery with even stronger balance sheets.
Sub-sector preferences: Industrial and Retail
We believe the industrial sub-sector will be resilient, delivering DPU growth on the back of AEIs and acquisitions. Industrial REITs have been the most active in acquisitions, owing to an early recovery in their share prices. Retail will benefit from the return to normalcy and pickup in social activity post-relaxation of COVID restrictions which will help lift tenant sales and sentiment.
Retail (OVERWEIGHT). Retail occupancy hit a 10-year low in 2020 but has since rebounded to 92% and we are starting to see rents bottom out. Reversions for suburban malls are starting to turn positive while negative reversions for downtown malls are narrowing. There is also very little new supply hitting the market. Return to office and a pick-up in social activities should help lift tenant sales and return confidence back to retailers. We are overweight on the sector, especially suburban malls, which despite their resilience during the pandemic, are still trading 15% below pandemic levels.
Office (NEUTRAL). The office market is showing signs of recovery. Core CBD rents posted three consecutive quarters of growth, although occupancy at 88% is still 2ppts below the 5-year average. We are neutral on the office sector as supply is slightly elevated. The 3-year average supply of 1mn sq ft p.a is above historical 5- and 10-year averages. While return to office should allow occupiers to better evaluate their space need and result in more decisive renewal discussions, we are cautious that more downsizing could occur, leading to oversupply in the near term.
Industrial (OVERWEIGHT). Rents have bottomed out after declining for 7 years while occupancy has recovered back to 2016 levels due to better occupancy at factories and warehouses. Industrial REITs benefit from the secular growth of new economy tenants such as tech, life sciences, biomedical, semi-con and electronics manufacturing, which typically locate themselves in high-spec, science and business parks and warehouses. We are also seeing structural shifts, such as e-commerce and manufacturers moving from just-in-time inventory management to just-in-case in view of supply chain disruptions.
Hospitality (NEUTRAL). Feb22 revenue per available room (RevPAR) jumped 77% YoY on the back of higher occupancy and average daily rates, but was still 41% below 2019 levels. The hospitality sector faces a long road to recovery. We estimate that the industry may only return to pre-COVID levels in 2024, in line with the World Tourism Organisation forecast. DPU yields are expected to be depressed as DPUs recover over the next two years. While we expect more price recovery for hospitality REITs, in view of recent share price appreciation, we see more upside for retail and industrial SREITs.