REITs’ hold up despite market turmoil

• High inflation and interest rates have dampened REITs' distribution yields in recent quarters, with the Singapore and Canada markets most heavily impacted.
• This is represented in KPMG’s last Financial Performance Index (FPI) scores for the sector, which have declined to below 80 (out of 100) in those two countries, below the usual cross sector average for FPI scores.
• In North America and Asia, Data Centers is the strongest performing REITs segment, enjoying returns of 19.4 percent in 1H23. Office, Retail and Industrial are among the worst performing, due to a weak recovery in demand failing to match supply since the pandemic, and rising costs.
• Global REITs are less leveraged today than during the 2008/09 crisis; while valuations remain volatile, yields are typically attractive and cases of serious distress have been rare.

Amid capital market uncertainty and mortgage market turbulence, real estate investment trusts (REITs) have proved remarkably resilient, maintaining sound operations, robust balance sheets, and successful equity and unsecured debt issuances. Prior to COVID-19, REITs benefited from regulatory efforts to strengthen their balance sheets - notably by reducing leverage levels. However, the economic impact of the pandemic has prompted a reassessment of REITs' business strategies, leading to a reduction in debt, a more conservative approach to development, and an emphasis on higher credit quality in portfolio assets. 

REITs have also responded by lowering leverage and laddering debt maturities. Over the past decade, leverage has decreased significantly, thanks to prudent financial policies to enhance creditworthiness. Having peaked at 38 percent in the 2008 global financial crisis, the average REIT loan-to-value ratio now stands at around 33 percent.

Over the last six quarters, the Financial Performance Index (FPI) index has returned above-par scores (>90 out of 100) for all geographies except Singapore and Canada. However, like real estate, REITs have faced macroeconomic headwinds - particularly surging interest rates and inflation - narrowing the yield gap with `risk-free' money market opportunities such as government bonds.

REITs performance – by major REITs (August–October 2023)

Source: SGX Research (October 2023)

Singapore's potential 

At US$93 billion, Singapore has one of Asia's largest REITs markets, although its value has fallen by 7 percent month-on-month (M-o-M) since August 2023. Moreover, REITs represent 12 percent of the entire Singapore stock market (SGX) capitalization. There are 42 REITs listed on SGX, 90 percent of which hold overseas assets. As of October 2023, the average dividend yield of S-REITs stood at 7.7 percent, down from 8.7 percent in May, presenting an attractive return compared to the Straits Times Index (STI), government bonds and term deposits.

Sector high- and low-performers

Data Centers, Industrial, and Self-storage have been the strongest performing REITs categories in 2023. According to Nareit (National Association of Real Estate Investment Trusts) Data Centers lead with a YTD return of 19.5 percent, followed by Timber (11.2 percent), and Self-Storage (8.4 percent). Propping up the rankings are Office and Infrastructure, generating negative returns of 12.0 percent and 10.7 percent respectively, due primarily to a soft US real estate market. Nareit predictions indicate that Manufactured Homes and Industrial segments are likely to drive the market in the next 5 years, through growth in rent and occupancy.

REITs remain a favourable investment option for investors in the medium to long term. REITs are not a homogenous asset class though, and there are marked differences in their performance depending on the asset class, geographical concentration, size, financial strength of the sponsor, and maturity profile of their existing debt. For investors who are willing to put in the effort to carry out the necessary due diligence, REITs can be an attractive addition to their portfolios.