How Fed tapering woes could spook the S-REITs sector

They're starting to lose ground.

According to OCBC Investment Research, the recent respite in the unit prices of S-REITs resulting from the delay in the US Fed tapering was short-lived.

OCBC noted that an impending reduction in bond purchases will continue to spook interest-rate sensitive stocks such as S-REITs.

Here's more:

After the US Central Bank surprised the market with its decision not to scale back its bond purchase programme on 18 Sep 2013, the FTSE ST REIT Index recovered 3.8% to reach a high of 750.27 on 30 Oct, outperforming the 1.6% growth in STI over the same period.

However, in the weeks that follow, the S-REITs sector started to lose ground again, as talks on the potential QE reduction (as early as Dec) resurfaced amid stronger-than-expected US economic data.

Looking ahead, we believe mounting risks from an impending reduction in bond purchases will continue to spook interest-rate sensitive stocks such as S-REITs, leading to a potential share overhang or even further downward pressure from here.

Fundamentals remain sound

Nevertheless, we note that S-REITs are now fundamentally stronger, as they have been capitalizing on the low interest rate environment to embark on assetenhancement works to rejuvenate their assets and acquire quality assets.

For FY14, we still expect the S-REITs under our coverage to register a robust DPU growth of 6.2% on average, hence enhancing the sector yield. In addition, S-REITs have been very prudent on their capital management, in anticipation of the potential rise in interest rates spurred by the QE taper.

For example, most S-REITs have actively refinanced their borrowings over a longer term, thereby extending their debt maturities and lowering their financing costs.

More importantly, a major portion of their existing borrowings have been locked into fixed rates through the issuance of fixed-rate notes or interest rate swaps. This is expected to limit the impact of rising interest rates on the S-REITs’ DPUs over FY14-15 in our view.

Slightly more compelling following price correction

In addition, the yield spread between the S-REITs sector and Singapore 10-year government bond yield – a proxy for attractiveness – has widened to 450bps from 425bps since 18 Sep, as the correction in S-REITs’ unit prices more than offset the rise in the government bond yield.

To-date, S-REITs remain the market with highest yield spread as compared to the other major geographies.

Should there be further pull-back going forward, S-REITs may turn more compelling and prompt some investors looking for yield plays to re-visit the sector.