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Are high yield REITs worth the risk?

REITs

Written by:

Alex Yeo

In a high interest rate and high inflationary environment, investors look for higher yielding assets such as dividend plays to secure a higher rate of return for their investments and beat inflation.

One option is to invest in REITs as REITs provide a steady and regular stream of dividend income and also have the potential to provide gradual appreciation in property value.

With US’s CPI index showing inflation at 9.1% for June 2022 and Singapore’s headline CPI index or overall inflation at 5.6% for May 2022, investors may want to look for assets that yield more than inflation to avoid a decrease in the purchasing power.

Here we look at 8 Singapore listed REITs that are providing a yield of at least 9%. We noticed that of these 8 REITs, 3 REITs have 100% of their assets in China and 4 REITs have 100% of their assets in the US and will analyse them as such.

High Yield Singapore REITs

TickerCompanyDividend Yield (%)Gearing ratio (%)Price to book ratio (times)3 year compounded total return* (%)
CEDUDasin Retail REIT16.837.80.2-23.1
BWCUEC World REIT9.637.30.70.5
CRPUSasseur REIT9.026.20.89.9
K71UKeppel Pacific Oak US REIT9.137.50.96.5
BTOUManulife US REIT9.542.80.9-5.2
OXMUPrime US REIT9.539.10.91.2
ODBUUnited Hampshire US REIT9.938.90.88.9**
AW9UFirst REIT9.035.70.9-26.1
*Total return includes dividend and capital gain/loss, **2 year compounded

3 REITs with 100% of assets in China

These 3 REITs have seen their share price crash in the last 12 months, with Dasin Retail REIT down 43%, EC World REIT down 39% and Sasseur REIT down 21%.

This decline was due to the Chinese real estate industry credit crisis causing Dasin and EC World to face challenges in refinancing their loans that were due. Sasseur was spared as its borrowings are due in 2023. We first covered the situation here in April 2022.

Since our coverage in April 2022, Dasin REIT was only able to negotiate an extension of these borrowings to mature at the end of 2022 (pending the approval of one lender) while it continues to explore its options of selling its prized assets to meet its financial obligations.

Similarly, EC World negotiated an extension of the maturity of its loan facilities by 10-12 months to April 2023, allowing it to have sufficient time to complete its on-going refinancing exercise. This is conditional on the REIT repaying 25% of its loans by end of 2022 and was deemed onerous by the market. Similarly, EC World is also exploring various fund-raising options including the potential divestments of non-core assets.

With Sasseur’s refinancing coming up, should the Chinese real estate industry and economy remain in the current state, we may see Sasseur following in the footsteps of the other two REITs.

While these are definitely negative news which has caused the share price to fall, the biggest upcoming milestone for Dasin and EC World is whether they have the ability to sell their assets at market valuations so as to main the net asset value of the REIT.

With these REITs having somewhat reputable sponsors and quality assets, they have shown the market that they been able to extend the maturity of their borrowings, giving them time to carry out their refinancing exercises. Hopefully this will be executed at a reasonable risk premium which should help keep costs low in the current low interest rate environment in China.

The biggest risk of investing in REITs is the default risk as not being able to successfully refinance could mean a collapse as assets are sold at fire-sale prices with residual equity left for shareholders. With such a frightful downside versus the upside potential in a successful refinancing, investors have to seriously consider how confident they are of the REIT’s ability to tide through this storm.

Taking into consideration the risk, we think that a 9% yield is not enticing enough for us to take the risk, however for Dasin REIT with a near 17% yield and a P/B of 0.2 times, this could be one for the adventurous.

4 REITs with 100% of assets in US

Keppel Pacific Oak (KORE), Manulife (MUST), Prime and United Hampshire are all yielding more than 9% and have a gearing ratio of between 37.5% to 42.8%. All 4 REITs have reputable sponsors such as Keppel, Manulife, KBS and UOB.

The trio of KORE, MUST and Prime, all of which are pure US office plays, have recorded a YTD total return decline of greater than -10% while United Hampshire which invests in grocery and necessity properties and climate controlled self storage properties recorded a decline of -5.6%.

The trio of US office plays were expecting to see growth this year with the return to office trend as a cornerstone. Companies have been announcing plans to bring more employees back to the office and for more time each week. The correlation between COVID-19 cases and demand for office space has started to diminish, indicating stabilisation in the US office market. These three REITs also have assets of relative good quality, hence they typically see occupancy rates above the market average and tend to benefit from good rental reversions.

United Hampshire has viewed itself as a recession hedge due to the class of assets in its portfolio. While US consumer confidence was strong (as shown in the chart below), it has started to decline in recent months. As many of United Hampshire’s tenants are cycle agnostic, i.e., not affected much by economic cycles, United Hampshire should continue to perform resiliently.

The likely reason for the share price underperformance of these 4 REITs is the negative sentiment over the macroeconomic environment, specifically the interest rate environment and the risk of a mild recession. With the US 2 year and 10 year treasury yield both hovering at around 3% as compared to 0.25% and 1.30% just a year ago, this means that near term funding costs has increased by at least 2.75% since.

Due to the negative sentiments in the current market, the risk premium demanded has also increased. For example, for BBB credit rating issuers, the spread has increased from 1.1% a year ago to 2% now. This means that the funding cost for a BBB credit rating issuer is now 5% vs 1.35% a year ago, a large difference of 3.65%!.

Of course it takes time for the effect of higher interest rates to be fully priced in as REITs tend to have fixed interest rates for a large proportion of their borrowings. Should interest rates remain elevated for a prolonged period, The average cost of debt will move much higher and impact the REITs more significantly. In addition, should there be a downturn in the economy, rental rates would likely come down.

As these 4 REITs are all robust and yielding more than 9%, they could be worth the risk provided the recession is mild as what many economists are forecasting.

First REIT

First REIT is the biggest underperformer in our list. We previously covered First REIT in detail and included First REIT as an example on why it is not a good REIT investment. In summary, our views remain the same, First REIT is still not worth the risk.

With the challenges faced in its Indonesia assets, First REIT has been trying to diversity away from Indonesia. However, it is having a hard time finding acquisitions that tick the boxes.

Acquisitions made so far also do not seem like they benefit minority investors and with the REIT stuck at a low valuation, acquisitions is unlikely to look advantageous as any equity fund raising is likely to be significantly dilutive, forcing minority investors to put up more money.

Conclusion

Looking at the chart above, the current yield spread for the FTSE ST REIT Index as a whole is 288 bps or 2.88%, with the Singapore 10yr bond at 2.83% (slightly lower than the US 10 year treasury yield which is hovering at around 3%), this means that investing into the FTSE ST REIT Index would secure a yield of around 5.7%.

Although the REITs mentioned above provide yields of at least 9%, at least 3.3% higher than the index, this does not automatically mean that it’s a good investment.

The Chinese REITs have faced refinancing risks and it takes an extremely substantial discount such as in the case of Dasin Retail for them to look interesting.

The US REITs look like they are worth the risk at this point in time but that is with the assumption that the upcoming recession is mild as the operations of the REITs have been relatively robust and performed well this year thus far with the share price impacted by broader factors at play such as the higher interest rate environment and risk of a mild recession.

First REIT is a company that we will continue to avoid until we see the assets performing well and a good track record starts to build up.

1 thought on “Are high yield REITs worth the risk?”

  1. Hi Alex, just wanted to say that this was a great analysis, thank you for the article!

    Manulife US REIT is holding its 1H2022 financial results briefing on 4 Aug 11am at our office and both our new CEO Tripp and CIO Patrick and the rest of management will be present physically. Please email me if you’re interested to attend and meet them in person. They will be able to offer you more colour on what’s happening on the ground in the US office market 🙂 Thanks!

    Reply

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