Are S-REITs still a worthy investment in today’s climate?

I’m sure the topics of REITs have come up at least once when you were discussing with friends about what would make a good investment in Singapore. If not, you would have heard from older ones that property would make a good investment. However, for most of us, paying off our HDB loans would take more than half our working life. How to invest in property like that? Well, that’s where REITs come in. You can read more about what it is here.

Background

Before the pandemic hit, Singaporeans generally liked the idea of buying REITs as it was thought to be a stable income-generating tool, myself included. The 3Y maximum drawdown* before 2020 was 12.5% for the iEdge SG REIT index compared with 22.3% and 25.6% for the STI index and the SPY Index respectively. This volatility provided an average 3Y annualised total return of 13.4%. Not bad, right!

However, all that went out the window when the great sell-off in March came around. The iEdge SG REIT Index fell a whopping 33% in just over a month!

Source: TradingView

I definitely did not see that coming and this has made me question my understanding of REITs. Thus, I decided to do a little research. The ultimate question then is: are REITs still worth buying; and if so, which kinds should I buy into?

Sectors I'm positive on

With this pandemic well underway and there being no end in sight, I am positive on both logistics and data center REITs.

For logistics, the growth of e-commerce has been accelerated by covid. SEA, the parent company of Shopee, reported US$1.29 billion in revenue for Q2 2020, jumping 93.4% YoY from US$665.4 million in Q2 2019. Its gross profit also doubled within the same period climbing 106.1%. This quarter was when most of the world was in lockdown and online shopping became a favourite pastime. What this means for logistics REITs is that with increasing e-commerce sales, the warehousing demand for storage and fulfillment centers for distribution has soared as well. This means a greater demand for properties that are usually in a logistics REIT portfolio.

The growth in SEA’s e-commerce arm being reflected in its stock price

Source: TechinAsia

But is this sustainable?

Personally, I feel like once you start shopping online, there is really no going back. Sure, you could revert to shopping for clothes in malls for the experience. But the ease of online shopping would have become part of everyone's lifestyle and that would be hard to change.

For data centers, the reason is largely similar to that of logistics with the rapid adoption of tech at both work and school. A case in point is Zoom who smashed analyst estimates for their 2nd quarter earnings to record $663.5mn in revenue vs $500.5mn in estimates. This was partly due to the 4700% (yes, you read that right) increase in monthly active users YoY. What this means is that data consumption has soared during this period and will continue to soar.

With virtual meetings and classes becoming commonplace, more data centers would be needed to handle larger amounts of data. Resultingly, Zoom officially opened its newest data center in Singapore back in August and Facebook announced plans to open one here in 2022 as well. Even Amazon is joining in as they announced yesterday that they would invest $2.8bn in its second data center in India. As a result, all three^ SREITs who have a substantial portion of their portfolio in data centers have an average price return of 23% YTD with KDCREIT leading the way with a 41.35% return. In comparison, the index is down 9.3%.

But is this sustainable?

Personally, I feel that the WFH trend is here to stay. Sure, people might go back to office once the pandemic blows over. But this newfound convenience will have become so ingrained in our work/school life that it’ll be difficult to go back to the days when there were no Zoom meetings. Also, if you are unsure of what a data center is and its purpose, this is a good read on what data centers do.

Sectors that I'm neutral on

With the Circuit Breaker earlier this year, many small and medium-sized enterprise tenants in the retail sector were adversely affected as they were forced to shutter. This resulted in the government introducing financial support for them in the form of legislating that landlords defer/waive their rent. As a result, landlords such as CapitaLand and Frasers have seen their financial performance deteriorate as well.

Furthermore, not only are occupancy rates being affected but rental reversions+ across the board have been falling as well according to DBS. This would affect rental income and ultimately, net property income all else equal.

For hospitality, it is largely the same issue except that it is exacerbated by the lack of tourists due to closed borders. Even though the government has introduced a Temporary Enhance Bridging Loan Program (TBLP) and an enhanced Job Support Scheme (JSS) for the majority of the hospitality sector landlords, it will be tough for them to survive without tourists once these schemes taper off. Furthermore, the domestic tourism industry in Singapore is relatively small.

Unfortunately, global air traffic will not revert to pre-pandemic levels till 2023 at the earliest according to IATA and the government would be hard-pressed to keep up their stimulus for the hospitality sector till that time.

Source: IATA

Both retail and hospitality are bound to rebound but when that will happen is highly debatable. Therefore, I personally would only buy if I’m certain of their fundamentals and can hold for a long period of time.

So, is it worth buying still?

Overall, I would think that REITs are still a good buy because of two reasons. Firstly, MAS intervened by extending the timeline for a REIT to distribute at least 90% of their taxable income and increasing the leverage ratio from 45 to 50%.

What this means is that REITs now have the ability to manage their cash flow better and can redirect funds that were supposed to be paid out as dividends to more critical business needs first. Furthermore, with the leverage ratio being increased, they can take on more loans if necessary. However, even with the new measures, the average gearing ratio still stands at 36.4% as of 31 August 2020.

Secondly, we have seen some REITs evolved and adapt in this extraordinary time. One example is CRCT (SGX: AU8U), a retail REIT from inception, who recently made an announcement that they would be expanding their investment strategy to include office and industrial facilities (ie. Data centers). The market reacted positively to the news as the REIT rallied 4% that day.

Source: SGX

Final thoughts

All these measures helped REITs to have an average dividend yield of 6.6% as of 31 August 2020. A much better place to park your money than in HY saving accounts, FD, or even the STI Index if you are able to take up risk, don’t you think? (Do note that the yield should not be the sole factor when choosing a REIT) What are your thoughts? Do share them in the comments below!

*This is the maximum observed loss from a peak to a trough of a security, before a new peak is obtained. It is an indicator of downside risk over a specified period.

^These are Mapletree Industrial Trust (SGX: ME8U), Ascendas Real Estate Investment Trust (SGX: A17U), and Keppel DC REIT (SGX: AJBU)

+This is a metric for REITs that shows whether new leases signed in the current period have higher or lower rental rates than the period before

Note: The opinions expressed in this opinion are for general information purposes only and are not intended to be and do not constitute as financial advice. You should seek advice from professionals before making any investment decisions. Also, past performance is not a guarantee of future returns nor is it indicative of future performance.

Disclaimer: I hold positions in CRCT and KDCREIT