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Rising bond yieldsbond yields will limit cap rate compression and push up borrowing cost, making SREITs quite unattractive for investors.

Taking into consideration asset leverage, percentage of loans on fixed rates and average length of debt maturity, office REITs such as Suntec, KREIT and CDREIT are more exposed. Suntec and KREIT both have higher asset leverage and exposure to floating-rate loans, which could result in higher borrowing costs when rates rise. On the other hand, Tan finds AREIT, FCT and CMT least exposed given their lower asset leverage and high exposure to fixed rate loans. Are fears overblown? Despite the generally negative outlook on the SREIT market, investors should not overlook the SREITs ability to grow distributions, says Derek Derek Tan, analyst at DBS Group Research, said. He also cautions investors against joining the bandwagon sell-off based on potentially unfounded, market fears. Tan reckons that fears of the impact of rising bond yields on SREITs are an over-reaction at this point as QE is not expected to taper off anytime soon. Over the medium term, a rise in long bond yields is likely to be more gradual than abrupt and S-REITs continued ability to grow distributions (estimated at 4.0% YOY) is a compensating factor. Thus, we believe that the knee-jerk reaction seen in the SREITs share prices is unwarranted, she added. Tan notes that the magnitude of interest rate hikes that is being priced into the SREITs at present is far higher than even their most bearish market scenario. If investors were to cherry-pick wisely, certain SREITs might even present them with considerable capital upside and attractive returns.

nvestors are dumping SREITs as worries over rising bond yields take hold. In 2012, investors swooned over the Singapore REIT, or SREIT, sector, snapping up stocks due to their high returns amid a permissive low interest rate environment. But now many are selling off and fleeing into what they perceive to be safer markets.

SREITs losing their investment darling status

spread between SREIT yields and bond yields stood at 356bps on 21 June, an indication the sector is not any more attractive than it was prior to the correction, said Pang. At a turning point Tan Siew Ling, analyst at CIMB, also shares the grim forecast for SREITs and believes that the market is at a turning point of being fairly valued.We see few positive drivers for SREITs as tailwinds from interest rates and Singapore dollar have morphed into headwinds, impacting spreads, cap values and borrowing costs, said Tan. Tan explained that rising bond yields will limit cap rate compression and push up borrowing cost, making SREITs quite unattractive for investors. She notes though that the near-term impact of higher borrowing cost should be manageable given the healthy asset leverage, high percentage of hedges and staggered debt maturity seen in the sector. Meanwhile, as leveraged instruments, Tan notes that a spike in interest rates could result in a higher borrowing cost for REITs with lumpier refinancing, higher percentage of loans on floating rates and asset leverage. That said, she reckons SREITs are generally more prepared for any potential spike in borrowing costs and pullback in liquidity after the 2009 global financial crisis.

Sell-off gaining steam Concerns over US monetary policies, particularly the unwinding of the countrys qualitative easing program, have rattled investors in the SREIT market. The FTSE Straits Times Real Estate Investment Trust Index (FSTREI) has corrected by 16.8% over the last one and a half months alone from its peak, according to Pang Ti Wee, analyst at OSK-DMG. The long-term yield curve has also climbed steeply. Even though Pang sees bond yields stabilizing soon, investors are advised to remain prudent on the SREIT market due to the potential of rising debt costs and the compression in the spread between dividend and bond yields, following the increase in Singapore 10-year Treasury bond yields. Prior to the correction that began in the beginning of May, the yield spread between the SREITs and the 10-year Treasury bond yields stood at 381bps. Although the FSTREI has corrected by 16.8% since then, the
16 SINGAPORE BUSINESS REVIEW | SEPTEMBER 2013

Rise in SREITs yields in tandem with bond yields

Source: CIMB, Company reports