Yields are attractive but they are subject to movements in cyclical property market

High yields and strong results are making real estate investment trusts (Reits) stand out in a volatile market. But there is debate over their potential as defensive plays, with some market watchers cautioning that Reits are not necessarily safer bets because of their link to the cyclical property sector.

Most Reits turned in impressive results for the quarter ended June 30, 2008. The 18 which reported their performance before last Friday all achieved higher distributable income and distribution per unit (DPU) over the same period last year.

Distribution yields reported by the Reits, based on annualised DPUs and last Friday’s closing prices, ranged from 4.8 per cent to 11 per cent. Reits which offered yields above 10 per cent included MapleTree Logistics Trust, healthcare-related First Reit and Lippo- MapleTree Indonesia Retail Trust.

Overall, the Reits had an average distribution yield of around 7.8 per cent, offering a spread of over 4.6 percentage points above the 10-year Singapore government bond yield of 3.14 per cent on Friday. Compared with one-year fixed deposit rates which start from around 0.8 per cent, the Reits offered an even wider spread.

Analysts say Reits have largely performed in line with expectations. Their good performances have won them fans – with many trading at discounts to net asset values and thus offering relatively high yields, OCBC Investment Research said in a recent report that investors could ‘take a fresh look at S-Reits as defensive vehicles offering stable cash flows and high yields’.

However, others pointed out that Reits still may not match up to traditional defensive plays, including high-yielding blue chips like telcos and banks. While Reits do offer high distribution yields, the sector is influenced by movements in the property market, which tends to be more cyclical compared with, for instance, the telecommunications industry, or even banking, they say.

Distribution yields are also a function of Reits’ unit prices, so yields may look high simply because unit prices have dropped, explained one analyst. Considering both capital gains and distributions to investors, Reits have not done as well compared to around a year ago, he added. The FTSE ST Reit Index has fallen by more than 10 per cent since it was launched on Jan 10 this year.

Reit fans, on the other hand, argue that few sectors are completely resistant to economic slowdowns. Also, some Reits may be more resilient because they can lock in leases over several years, which helps stabilise earnings.

Where there is agreement among most of the market watchers BT spoke to is that Reits will continue to generate steady operating results. For those which have locked in leases or are able to gain from higher rental reversions on lease renewal, ‘there is a lot of predictability in terms of their earnings and distributions,’ said Daiwa Institute of Research analyst David Lum.

With credit conditions staying tough, however, much of the earnings growth will have to come organically. Reits may still acquire properties but they will have to be more selective, analysts say.

Analysts’ top Reit picks include Suntec Reit. ‘With 32.6 per cent of total office net lettable area up for renewal in FY09, we believe Suntec is well-positioned for rental reversion with current $14 psf signing rents versus passing rent of around $6.30 psf,’ said a Citi Investment Research report last week.

CapitaCommercial Trust was another popular choice. Goldman Sachs reiterated its ‘buy’ call on the Reit, favouring its strong organic growth and ‘leadership among office Reits’.

Source : Business Times – 4 Aug 2008