Ample liquidity and downward pressure on Sora are favourable for REITs, though other risks remain. Yields on 10-year Singapore Government Securities (SGS) fell to 2.62% as of March 10, a five-month low. Aside from a brief dip to 2.4% in September 2024, this is the lowest it has been in the past three years.
At the same time, the yield on the FTSE REIT Index is at 6.5%, a one-year high, giving a yield spread of almost 3.9%. This could cause S-REIT unit prices to rally to narrow the yield spread, as they have in past years.
In a report dated March 10, DBS Group Research notes that the one-month Sora, Singapore’s benchmark rate, “appears to have already peaked in FY2024.” The rate is currently stabilising within a range of 2.4% to 2.5%, suggesting relative interest rate stability in the near term.
DBS isn’t the only bank to recognise the declining interest rate environment in Singapore. On March 12, JP Morgan said it is upgrading REITs to Overweight from Neutral and downgrading Banks to Neutral from Overweight.
“Over the past few weeks, Singapore interest rates have declined by around 100bps, with the one-month Sora now near 2.4%. This lower rate environment translates into more pressure on banks’ net interest margins and relief in borrowing costs for REITs,” notes JP Morgan in its March 12 report.
Although S-REITs are an unlikely place to “hide” during a recession, JP Morgan reckons that a faster-than-expected 31% drop in six-month Singapore benchmark rates and lower one-month Sora down 100 basis points (bps) to 2.4% may see investors rotating to defensive yield plays.
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Against this backdrop, JP Morgan anticipates a 15% upside to the S-REITs’ September 2024 highs, when the risk-free rate was at its lowest in the past 12 months.
“There is further potential for lower rates, as JPM and the Street are expecting two/three Federal Reserve rate cuts by end-2025, with our economists highlighting a 40% risk of a US recession this year. We estimate a 4% upside to S-REITs’ DPU for every 100 bps fall in floating rates and anticipate that S-REITs will revise down borrowing cost guidance. Yield spreads are also supportive,” says JP Morgan.
Its top picks are Singapore-focused names, including CapitaLand Integrated Commercial Trust , CapitaLand Ascendas REIT , Keppel DC REIT, Frasers Centrepoint Trust and Mapletree Logistics Trust .
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Lower borrowing costs?
JP Morgan adds that S-REIT borrowing costs should trend down, with two-thirds of S-REITs at or above stabilised borrowing costs.
In particular, lower floating rates should benefit S-REITs with a high proportion of floating rate debt, such as CDL Hospitality Trusts , and those with a larger share of SGD-denominated debt, such as Frasers Centrepoint Trust, where borrowing costs could trend lower than the manager’s guidance.
Coupons for S-REIT bonds have also fallen to a three-year low of 3.2% from reduced spreads and a drop in three-year swap rates.
JP Morgan also notes that S-REITs are relatively more attractive, with yields at 6.3% compared to bank yields at 6.2%.
To this, the caveat must be added that banks pay out 50% to 60% of their earnings, compared to S-REITs’ minimum payout of 90% of distributable income.
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But, alternatives — including Singapore’s six-month T-bill rates — have fallen to 2.75%, and the 10-year bond yield is at 2.62% as of March 10. A widening yield spread could also trigger a temporary S-REIT bounce.
DBS’s report highlights the downside risks. With longer-than-expected inflation data, further interest rate cuts this year remain uncertain. Since the beginning of the year, the projected number and magnitude of these cuts have been revised down. As of early March, rate cut expectations have shifted up towards two to three cuts by the end of 2025, up from one to two cuts a few weeks ago.
“While still volatile and subject to economic data points, the ongoing tit-for-tat trade tariffs between the USA and their major trading partners is expected to rekindle inflation worries and even paralyse business growth plans. The elevated uncertainties could lead to a potential slowdown in the global economic outlook,” adds DBS.
