Not the end of the story

Retreat to Reits, trusts with visible dividend: analysts

US woes may have made markets view Reits for yield again, not growth

WITH rising uncertainty and volatile markets, investors should retreat to yield instruments such as certain real estate investment trusts (Reits) and business trusts, analysts say.

This is despite their weakness in recent months – according to a Goldman Sachs report last week, an index of Singapore Reits (S-Reits) has slid nearly 15 per cent in the last two months.

‘Price performance of Reits following primary and secondary equity offerings this year has generally been weak,’ it noted.

There might be several reasons for this weakness: broad market decline due to the credit crisis; widening yield spreads; or softer expectations for the property sector here.

But most analysts who have reduced price targets have done so because of higher cost of capital, which makes it more expensive for Reits to acquire. Weak market sentiment, too, affects acquisitions if there is lack of liquidity to fund equity raising, according to DBS Vickers.

As most Reits here have traded as growth propositions, rather than the stable dividend-payers they were designed as, the higher cost of acquisitions leads to loss of value.

Still, ‘with markets looking at increasing odds of a US recession and higher spreads for debt instruments – that is, a repricing of risk – the markets may have also decided they want to return to Reits as yield plays rather than growth plays’, said Lim Say Boon, chief investment strategist of wealth management at Standard Chartered Bank.

Indeed, analysts advise investors to buy into the visible cash flows and high dividends that Reits and trusts represent.

Despite higher cost of capital, ‘the strong Singapore structural story remains intact’ and S-Reits offer ‘defensive characteristics overlaid with growth’, said Goldman.

Others seem to agree. Suntec Reit, in particular, has drawn attention, with both BNP Paribas and Citigroup issuing ‘buy’ calls.

‘Concerns over prior yield compression and the narrowed spread against risk-free instruments have been overstated,’ said BNP’s Jonathan Ng.

Going by his forecasts, at Suntec’s closing price of $1.58 last Friday, its dividend yield spread against 10-year government bonds stood at 307 bps, higher than a previous peak of 291 bps in June last year.

Offering FY08 yield of 6 per cent, ‘the stock now trades at oversold levels’, said Mr Ng.

Other Reits offer still higher yields (see table). And we haven’t even come to the business trusts, which, according to some forecasts, are trading at FY08 yields of up to 10-plus per cent.

Nonetheless, investors should look hard at the underlying assets of Reits, not just at the yield they are offering, said Brian Tan, a wealth manager at FPA Financial. ‘Yields may be attractive but they can support the price only up to a certain extent,’ he said.

The comment is pertinent for the shipping trusts, namely Rickmers Maritime, FSL Trust and Pacific Shipping Trust. Despite high yields, these have performed poorly ‘generally due to the weak US dollar as shipping trusts generate US$-based cashflows’, DBS Vickers Research said.

Within the Reit universe, too, analysts differ on which stocks stand out.

Goldman prefers those with exposure to Singapore rather than overseas.

The yield spread of Reits like the CapitaRetail China Trust or Ascendas India Trust is negative, because the risk-free rates in China and India (at about 5 per cent and 8 per cent respectively) are higher than the Reits’ FY08 yields of 3.8 per cent and 4.2 per cent respectively, it points out.

Retail Reits should trade at the lowest one-year forward yields thanks to their low risk at this point, while industrial Reits should trade at the highest yields given low rental growth and shorter land leases, it said.

Citigroup strategist Lim Jit Soon advises clients to focus on stocks with good visibility and attractive yields. Top calls include Rickmers Maritime and Suntec Reit, as well as stocks like SPH and ST Engineering.

Meanwhile, another reason to look at high-yield stocks is that the local risk- free rate is expected to slide further – raising the yield spread – as economists expect the US Federal Reserve to lower its benchmark interest rate over the next year.

Singapore’s open economy means the government does not directly set the interest rate.

A 100bps decline in the Fed Funds rate will lower three-month SIBOR (2.56 per cent as at November 2007) by about 50bps, though this may take time to materialise, due to currency sterilisation and tight liquidity, according to Citigroup economist Zheng Kit Wei. But interest rates are ‘not the only factor driving asset markets’, he added. ‘Overall confidence and sentiment plays a part as well.’