Developers' whopping profits beat S-REITs' earnings

The FSTREH’s 23.8% growth is larger compared to the FSTREI’s 12.8% rise even after Fed hikes.

OCBC Investment Research is positive on the outlook of major Singapore developers with significant residential exposure in the nation and/or strong recurring income streams from diversified investment properties. “We believe the Singapore residential market has now entered a nascent stage of a potential multi-year recovery, amidst a firm economic backdrop and improving buyer sentiment,” a report said.

OCBC analyst Andy Wong Teck Ching noted that even if S-REITs will also be able to benefit from a stronger economic outlook, the impact will not be as pronounced as developers, given that rental leases are typically locked in for 3-5 years. “Furthermore, most REIT Managers have previously sought to limit downside risks for their unitholders by placing stronger emphasis on forward renewing their leases to lock in the occupancy levels, hence missing out on potentially higher rental rates in the near future to a certain extent.”

This is further emphasised by the point that the historical share price performance of the FSTREH has a relatively high correlation of 0.72 with changes in the URA Private Residential Price Index.

Also read: Is the worst over for S-REITs?

“Looking ahead, we forecast Singapore residential prices to increase 3% - 8% in 2018, and also project private primary sales transaction volume in the range of 12,000-15,000 this year. We expect this to be one key catalyst for Singapore developers,” Ching said.

Even if the share prices of both S-REITs and Singapore developers performed well during the last major rate hike cycle from June 2004 to June 2006 and the current ongoing cycle since Dec 2016, developers outperformed S-REITs on both occasions, OCBC said. “During the period from June 2004-June 2006, the FSTREH rose a whopping 110.3%, whilst the FSTREI increased 25.8%. From 14 Dec 2016 (when the Fed first raised the Fed funds rate under this ongoing cycle) till now, the FSTREH and FSTREI increased 23.8% and 12.8%, respectively. We expect this trend to continue,” the broker added.

Ching noted that domestic benchmark rates for mortgages (SIBOR/SOR) are projected to increase as most major Central Banks continue their policy tightening stance. “According to Bloomberg consensus’ average forecasts, economists are expecting the 3M SIBOR to hit 1.78% and 2.17% by end-2018 and end-2019, respectively. To put things in perspective, the 3M SIBOR was 1.50% as at end-2017, and last stood at 1.38%. Rising rates will likely partially offset fundamental tailwinds but we believe the overall impact is still manageable for developers and homeowners,” he added.

“As an illustration, if the 3M SIBOR rises by 125 bps to 2.63%, we estimate that the monthly mortgage payments for an owner of a second home in Singapore worth $1m will increase from ~$2,200 to $2,600, under a 60% LTV ratio and 30-year loan tenor assumption. This is unlikely to create a significant increase in financial strain for the homeowner. For investment home owners, the anticipated recovery in housing rentals ahead will also help to alleviate the pressure on rental carry from higher rates,” Ching added.

OCBC noted that despite a more robust outlook for developers as compared to S-REITs, the FSTREH is still trading at a large discount to NAV and also against historical averages. During property bull-cycles, developers have traded at a premium to their NAV.