Calvin Goh is a Portfolio Manager with the Asian Equities team at Lion Global Investors. He is responsible for covering the real estate sector and has nine years of financial industry experience.
Dawn Leong: The Fed has finally paused its interest rate hike in June, after 10 consecutive hikes of 500 basis points over the past year. While the dot plot is suggesting one to two more hikes for the rest of 2023, markets are already pricing in cuts for 2024. As we know real estate is a sector that is very sensitive to interest rate movements.
Historically, when the Fed stopped raising rates, Singapore Real Estate Investment Trusts or what we also call S-REITs, outperformed the Straits Times Index, which is a widely recognised benchmark index for the Singapore stock market by about 4% to 7%. With that said, how do you think investors should be positioned on the back of Fed’s eventual pause and even cuts of interest rates headed into 2024?
Calvin Goh: I think it is too early to tell if the market is right or being too optimistic in pricing in rate cuts in 2024. I think this is very much dependent on the inflation data, the strength of the US economy, and the Fed’s assessment of the appropriate interest rate to bring inflation back to the 2% inflation target.
However, you are right in saying that there is a growing consensus that we are reaching peak interest rates after 500 basis points of interest rate hikes since March 2022 and historically, the period of pause after a period of interest rate hikes has been very good for S-REITs.For instance, from December 2015 to December 2018 there was about 200 basis points of interest rate hikes. From the last interest rate hike in December 2018 to the first interest rate cut in July 2019, the S-REITs sector as a whole grew by 15% and outperformed the STI index by almost 700 basis points.
In terms of positioning, my view is that S-REITs are potentially attractive investments for investors who value the stability of income returns and some moderate capital appreciation.
At the fundamental level, the stabilisation of interest rates and eventual interest rate cuts will allow S-REITs to carry out more M&A (Mergers & Acquisitions) activities to grow their asset base, potentially lower interest expenses, and improve their overall valuation.
Dawn Leong: Well, thanks so much, there is just so much to unpack.So I just want to quickly summarise for our investors.So when the Fed pause or bring their interest rates down, it will lower the borrowing cost for their S-REITs and have a positive knock on impact on their earnings and possibly for more M&A, and we like the big blue chip guys with solid balance sheets.
I want to talk a little bit on the slowing growth globally. The US is likely to be headed into a recession later this year or early next year. Growth in the Eurozone is facing headwinds, and China’s economy seems to have stalled. So taking everything into consideration in today’s macro environment, how do we feel about Singapore Real Estate as an asset class? Are there any sub sectors that we like at the moment?
Calvin Goh: I think the Singapore Real Estate sector is appealing to investors who value the stability of a steady stream of income and moderate capital appreciation. Today if you look at the bigger cap like the S-REITs, giving us a dividend yield anywhere between a range of 5.5% to 6% and potential capital appreciation of a high single digit for total return of somewhere between the low and mid-teens.
For this kind of return, I would say that Singapore REITs are pretty appealing if you consider the limited downside risks involved. In terms of sub sectors, I like industrial, retail, and data-centre REITs. I think that Singapore industrial REITs are going to continue to enjoy structural tailwinds that come from companies trying to build supply chain resilience and growing e-commerce penetration.
I think it is also worth remembering that many of these Singapore industrial REITs have exposure to overseas markets like in Australia where there is strong growth. In Australia, the industry vacancies are less than 2% and we are seeing positive rental reversion in a range of 20% to 30% year-on-year.
Dawn Leong: Yes, there is an additional benefit of diversification in this case.
Calvin Goh: Exactly, I also like retail REITs. It is set to benefit from Singapore’s favourable supply and demand dynamics because there is a limited number of new malls that will open in Singapore in the next few years.
I think suburban malls catering to non-discretionary spending will continue to do well because they cater to the day-to-day living needs of Singaporeans. For malls with exposure to discretionary spending, it is also set to benefit from more tourists returning to Singapore and the rising affluence of Singaporeans in general.
I also like data centres as a structural growth theme.As more people use tools like ChatGPT and as more companies invest in Generative AI training, we are going to have a need to build more data centres with higher power densities and greater cooling capabilities to deal with all the GPUs and the processing power that comes along with it.
I think these data centres will continue to enjoy low vacancies and positive rental reversions. I think that this theme of data centres will be a growth theme with us for the next few years.
Dawn Leong: Absolutely agreed. Everything now is in the clouds. So, data centres are definitely going to be a very interesting structural long-term theme that we like within Singapore Real Estate.
The US commercial real estate space has seen signs of faltering recently, on the back of massive interest rates hikes that we spoke of and the banking crisis earlier this year. It has definitely tightened lending conditions, and also since the pandemic, work from home trend has fundamentally changed the work paradigm for office space. Are we also facing similar concerns here in Singapore?
Calvin Goh: Definitely not. I do not expect to see the same kind of distressed office opportunities and defaults in the US real estate market to happen in Singapore.
Firstly, it is important to recognise that the supply and demand dynamics in the US are very different compared to Singapore. The US is a big market. There are many cities and some of these cities are facing an economic slowdown which translates into weaker commercial leasing demand and higher tenant incentives.
In Singapore, on the other hand, we have one core CBD and economic growth has been quite resilient. I think the GDP growth for the second quarter was up by about 0.7% year-on-year. In the last few years, we have generally seen rising rents and tight vacancies. This is mainly driven by a lack of new supply and strong demand from the banking sector, family offices, and asset managers.
Secondly, I think that ownership matters. In key metropolitan areas like New York, the office sector is a lot bigger and many of them are privately-held, like older buildings for historical reasons. In contrast, the Singapore office market mainly consists of newer office buildings owned by REITs and institutions.If the office is institutionally owned, especially by REITs, with strong pre-leasing commitments and high occupancies, it is very difficult to imagine a scenario where there will be distressed asset sales with steep price discounts because these guys have strong holding power.
Thirdly, I think that the return to work trend is stronger for Singapore compared to the US since the remote work culture is generally weaker in Asian countries.I think many of us go back to the office two to three times a week but this is not necessarily the case in the US market.
Dawn Leong: Maybe in Singapore, we are smaller here so it is easier to travel on MRT and buses. We do not need to work remotely all the time.
Calvin Goh: Exactly. In summary, I think there are strong contrasts between the US and Singapore office markets. At a fundamental level, the office REITs are still seeing positive rental reversion with high occupancies in the nineties. So, I would not be too worried about the office sector.
Dawn Leong: Well, sounds like we are in good shape then! Thanks so much Calvin for being here with us to discuss the outlook for Singapore Real Estate.Your insights have been very helpful to us.
*All data are sourced from Lion Global Investors and Bloomberg as at 28 July 2023 unless otherwise stated.
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