• The S-REITs Index performance was lukewarm in March after the FOMC held rates steady at 5.25-5.5%. It gained 0.6%, following the 5.1% decline in February. The top performer for the month was Manulife US REIT (MUST SP, non-rated) – it gained 40% but is still down 3.8% YTD. The worst performer was Daiwa House Logistics Trust (DHLT SP, non-rated), a drop of 7.8% after the Bank of Japan raised interest rates to 0-0.1%, ending its eight-year period of negative interest rates. The overseas commercial sub-sector was the top performer in March, gaining 10.8%, lifted by the Singapore-listed US office REITs. It is, however, still down 22.7% YTD. The worst performing sub-sector was overseas diversified, down 2.2% in March.
• S-REITs are now trading at a forward dividend yield spread of c.3.2% (-1.3x s.d.) and a P/NAV of 0.88x (-1.7x s.d.).
• We remain OVERWEIGHT on S-REITs but are selective. We favour REITs with a healthy balance sheet, strong sponsors, and improving operating metrics, such as REITs in the hospitality and retail sub-sector. Catalysts are expected from a pick-up in the economy, asset recycling, and interest rate cuts. CapitaLand Ascott Trust (CLAS SP, ACCUMULATE, TP S$1.04) and Cromwell European REIT (CERT SP, BUY, TP €1.91) are top picks.

SECTOR ROUND-UP

The Fed kept federal funds rate unchanged at 5.25-5.5% for the fifth straight meeting on 20 March, resulting in the S-REITs Index’s lukewarm share price performance. The Fed remains on track to cut interest rates this year but will need to see more positive signs that inflation will move towards its 2% target. 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 recently initiated Cromwell European REIT with a BUY recommendation and a target price of €1.91. We like CERT for the following reasons: 1) it has a resilient portfolio with high portfolio occupancy (FY23: 94.3%) and rental reversions (FY23: 5.7%); 2) it has a commendable divestment track record since FY22, and another c.€160mn of divestments in the pipeline to keep capital management in check; and 3) most of its leases have annual rental escalation clauses that are based on the YoY increase in CPI.

Retail

Feb 24 retail sales index (excluding motor vehicles) rose 9.4% YoY, reversing the 1.8% decline in Jan 24. The improvement was mainly due to Chinese New Year being celebrated in February this year, compared to January last year. Comparing the performance for the two-month period (January and February), retail sales rose 4.7% in 2024 YoY. The food & alcohol and supermarkets & hypermarkets industries were the outperformers at +31.4% and +19.2% YoY, respectively.

The F&B services index rose 14.7% YoY in Feb 24, after a 5.5% decline in Jan 24. All industries recorded YoY growth, with food caterers and restaurants registering +39.5% and +20.5% respectively. We think retail sales will remain resilient in 2024, boosted by the extra S$600 in CDC vouchers, cash payments of S$200 to S$400 for eligible Singaporeans, and S$200 in LifeSG credits for all national servicemen.

Hospitality

Singapore’s international visitor arrivals grew 45% YoY in Mar 24 to 1.48mn, boosted by the Taylor Swift concert. It is now only 5% below pre-COVID levels (Figure 8). The return of Chinese travellers quadruped YoY in March 24 and is now 17% below pre-COVID levels after the 30-day visa-free entry for Chinese citizens rolled out on 9 February 24.

RevPAR continued to grow (+8% YoY) in Feb 23 after gaining 13% YoY in Jan24, supported by higher average daily room rates (+9% YoY). RevPAR was boosted by the Ed Sheeran concert and the Singapore Airshow. We think RevPAR will continue its growth trajectory in 2024 with a solid concert line-up and a packed MICE schedule in Singapore.

INVESTMENT RECOMMENDATION

OVERWEIGHT on SREITs (Maintained)

S-REITs are now trading a forward dividend yield of c.6.3%, 0.4x s.d. above the mean of 6.1% (Figure 5) and a P/NAV of 0.88x, 1.7x s.d. below the mean of 1.03x (Figure 4). As we enter the monetary easing cycle, we think this is a good time for investors to reposition into SREITs. We expect flat to low single-digit DPU growth in FY24.

Due to the recent share price performance, the dividend yield spread is now at 3.2%. It is 1.3x s.d. below the mean of 4% (Figure 2). With interest rates widely expected to decline in 2H24, we expect the dividend yield spread to 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 due to 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 expect tenant sales to remain resilient due to increasing 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. The return-to-office trend and the slew of 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 expected for downtown malls, supported by the return of Chinese travellers. 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 $11.90 psf pm in 4Q23 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 reach Singapore. This could affect office leasing momentum and sentiment, and we, therefore, anticipate office rents to be muted in FY24.

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.