Asia REITs: Time to Bask in the Sun
REITs shine as interest rates head lower. With inflation tapering off and other macro datapoints in the US showing signs of softening, the Fed has turned visibly dovish, signalling their readiness to...
Chief Investment Office - Hong Kong version5 Sep 2024
  • Expectations of Fed rate cut at the September FOMC meeting set the stage for yield sensitive assets like REITs to return to prominence
  • Impact of higher interest costs have peaked; REITs with lower hedge profiles to benefit ahead of others
  • Investors to refocus on property fundamentals; suburban retail, data-centres, and logistics are well-placed to deliver steady growth
  • Merger and acquisition activity could pick up, presenting upside surprise to REITs’ distributions
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REITs shine as interest rates head lower. With inflation tapering off and other macro datapoints in the US showing signs of softening, the Fed has turned visibly dovish, signalling their readiness to cut interest rates at the Federal Open Market Committee (FOMC) meeting in September. With global interest rates now on a normalisation trend amid declining macro headwinds, we have seen a pick-up in performance for REITs in recent weeks. Given close inverse correlation between interest rates and REITs prices, we remain confident that REITs, especially those in Hong Kong and Singapore offering yields of 6-7% on average, will continue to see strong inflows from investors in the months ahead as they seek high yielding opportunities.

Interest costs peaked; lower-hedged REITs positioned to benefit. The impact of rising interest costs on Singapore REITs (S-REITs) appears to have peaked in the first half of 2024. Given recent declines in short-term interest rates across Asia and the expectation of further cuts in 2025, refinancing costs are likely to stabilise. Assuming a typical three-year loan rollover, the overall cost of borrowing could decrease, particularly for REITs with higher exposure to floating rates. Throughout the first half of 2024, REIT managers have been gradually unwinding hedges, positioning their portfolios to benefit from falling rates. Our sensitivity analysis indicates that for every 100 bps drop in interest rates, S-REITs could realise up to a 2.4% increase in earnings in 2025, a factor that is not yet reflected in current valuations.

Investors to refocus on property fundamentals; suburban retail, data centres, and logistics are well-placed to deliver steady growth. With declining macro headwinds, investors will likely refocus on underlying property fundamentals. Across Singapore and Hong Kong, we like suburban retail subsectors where growth is underpinned by resilient retail tenant sales amid limited new retail supply, driving the landlords’ ability to raise rents. In addition, secular trends underpinned by e-commerce, Generative Artificial Intelligence (Gen AI) will drive continued demand for data centres and logistics properties. We turn more cautious on hotels with expected softness in demand as most hoteliers have become more price sensitive, given the slower-than-expected pick-up in China demand.

Merger and acquisition activity could pick up, presenting upside surprise to REITs’ distributions. Lower interest rates will be a boost to the overall operating environment as it spurs more transaction activities. As the cost of capital turns more conducive for REITs to pursue accretive acquisitions, S-REITs will be back in a ‘virtuous cycle of growth’. This has not been priced in by investors and will present an upside surprise should it transpire eventually.

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