We downgrade the M-REIT sector to Underweight. The attraction of yields for the M-REITs will be eroded as bond yields are expected to stabilise at a new higher level. The S-REITs have already been hit with FSTREI falling by 15% from its recent high in May 2013. The M-REITs, however, have yet to fully price in the risk. We adjust our valuations for all the M-REITs under our coverage by raising our discount rate assumptions by 50-80bps.
- Bond yields normalising to new levels. Given the rising bond yields environment, we believe the attraction of yields for M-REITs will be eroded, as the spread for M-REITs will become narrower. This trend is likely to persist over the next one year as bond yields gradually adjust to new high levels, after staying at an average low of 3.44% over the past 12 months.
- S-REITs the leading indicator. Given the more open Singapore economy, the S-REITs have already experienced a sell down last month, with FSTREI falling by 15% from its recent high in mid-May 2013. The Singapore 10-year government bond yield has already increased by 120bps since early 2013. Based on the current yield of 2.51%, the spread for the S-REITs has lowered to 239bps compared to 365 bps in 1Q13. Despite the recent mild correction, we believe the market has underestimated the downside risk for the M-REITs, partly also because of the slow adjustment in the Malaysia 10-year government bond yield.
- Inorganic and acquisition growth insufficient to offset the risk, Even if some of the M-REITs could still have the catalysts of organic (via rental renewals and AEIs) and acquisition growth, the positive impact is not enough to offset the risk of higher bond yields. The higher M-REITs yield (after the unit price correction) will also make new acquisitions tougher, as new assets are expected to be yield-positive, and new debt funding will be more expensive as the banks will likely gradually price in higher interest rate risk by raising lending rates.
- Downgrade to Underweight. No more yield compression. We adjust our valuations for all the M-REITs under our coverage by raising the discount rate by 50-80 bps in order to reflect the higher yields environment. We downgrade CMMT, Axis REIT and Quill Capita to SELL due to their more demanding valuations, and less encouraging prospects for the office sub-segment (for Axis and Quill). Similarly, although we still like Pavilion REIT due to its asset quality, given the changes in the macro environment, we also downgrade the REIT to Neutral. Ratings for other REITs remain the same with lower fair values.
Publish date: 12/07/13