Refinancing Risk to surface
- Refinancing risks as SOR rate rises
- Acquisitions to complement modest organic outlook
- Picks MAGIC, MCT, FCOT and CDL HT
Refinancing to cost more. The recent increase in the benchmark 10-year yield to 2.3% and 30-50 bps rise in the 3-month/3-year swap offer rates (SOR) could cap upside to S-REIT unit prices. Although most S-REITs have hedged the bulk (estimated 75%) of their debt at fixed rates, these will start to expire starting 2015 and they would be more expensive to roll over. We estimate a 1% hike in the refinancing rate on debt renewals in 2015 and 2016 would reduce distributions by an average of 2.0% (ranging from 0.0% to 5.6%). This suggests average FY16F yield might dip as much as 15 bps to 6.05%, and there would be only marginal growth this year. As refinancing risks rise, we may see limited upside for S-REIT unit prices from current levels.
Modest 4% growth in distributions over FY15-16F. The outlook guidance for 2015 remains modest for most sub-sectors with estimated c.4% growth in distributions over FY15-16F. Retail REITs remain cautious of the rental outlook amid rising occupancy costs as average portfolio tenant sales remain static. Industrial REITs continue to see acquisitions as rental growth moderate due to the competitive operating environment. For office REITs, the squeeze in CBD space remains a key catalyst for landlords to remain optimistic of near-term rentals, and we are seeing demand flowing into the business park sub-sector (both A-REIT and MINT saw back-filling of vacant space at Changi Business Park). Despite a better outlook for 2015, Hospitality REITswill see near-term weakness but remain optimistic that a strong line-up of events in Singapore this year will improve tourist arrivals. Most are looking outside Singapore for opportunities.
Acquisition-led growth partly funded by new equity. Supported by conservative c.33% gearing and ample access to capital, most S-REIT managers can continue to gear up for growth. But we are cautious of rising gearing levels at the start of an interest rate upcycle. The S-REITs are currently trading at 1.1x average P/Bk NAV, which suggests the managers may partly fund acquisitions by raising new equity, so as not to dilute NAV substantially. Sponsored REITs and industrial/hospitality REITs offer stronger visibility in termsof acquisition-led growth.
Picks. The current yield spreads, at 3.7%, are close to historical trading levels. Hence, we see limited upside to S-REIT unit prices going forward. Our top picks are REITs with strong growth potential like MAGIC, MCT, FCOT and CDL HT.