Hello, savvy investors! Welcome back to ‘The Dividend Uncle’. In today’s post, we’re diving into a crucial update for investing in May 2024. We’ve identified three riskier REITs that I am avoiding due to their idiosyncratic risks and specific circumstances. These specific situations have expanded the existing risks already faced by REITs arising from the current volatility in interest rate expectations.

But don’t worry, The Dividend Uncle has also pinpointed two super stable and safer REITs that can easily replace these riskier options in your portfolio. So, let’s get into the details and help you make informed investment choices.

But before we start, I wanted to share some happy news. My buddy Jun Yuan, founder of “The Singaporean Investor” website, has just published his book on “Building Your REIT tirement portfolio”! It provides a step-by-step guide for investors to build their investment portfolio consisting of REITs, and also a section on commonly asked questions about REIT investing. It is currently available in Kinokuniya, and will be available in Popular very soon. If you are interested, head down to take a closer read!

Now, I must let you know that the content of this post is for informational and educational purposes only and does not constitute financial advice. The opinions expressed are based on publicly available information and personal analysis, and they are not tailored to your specific financial situation. The REITs and institutions mentioned are cited purely as examples. While I have no affiliations, sponsorships, or financial relationships with any of them, I may personally hold positions in some of the investments discussed. Before making any investment decisions, you are strongly encouraged to consult a licensed financial adviser.

Okay, let’s jump right into today’s post.

Idiosyncratic Risks may outweigh even the interest rate volatility

Over the past few months, we’ve witnessed significant volatility in expectations around interest rate cuts. Interest rates are crucial for REITs because they are highly leveraged, with the average gearing of Singapore REITs close to 40%.

REITs have generally been declining since the start of the year due to persistent inflationary pressures. Expectations of rate cuts by the US Fed in June are now unlikely. Just a few weeks ago, hotter-than-expected inflation figures led analysts to believe there might not be any rate cuts this year. Then, out of the blue, lower-than-expected consumer prices last week brought rate cuts back into the picture. These episodes show how volatile expectations can be. For long-term investors, we shouldn’t be too concerned with these short-term fluctuations. As long as we believe rate cuts will eventually come, current pressures on REIT prices present good entry points for us.

On top of the volatility due to interest rate expectations, the idiosyncratic risks may result in substantial uncertainties for certain REITs. It is important to identify REITs where their specific risks are substantial and may cause their longer-term value proposition to falter. In such cases, it may be worthwhile to avoid investing in them, and wait out the uncertainties.

So, here are the 3 REITs I will be avoiding in May 2024, along with 2 REITs that can easily replace them.

Avoiding 3 REITS with Substantial Specific Risks

1. Keppel DC REIT – a classic case of tenant concentration risk

Keppel DC REIT is currently grappling with significant challenges, primarily due to issues with its tenant in the Guangdong data centers. The tenant, Guangdong Bluesea Data Development, has defaulted on rent payments, contributing to a substantial decrease in Keppel DC REIT’s FY2023 distribution per unit or DPU. The situation has led to margin compression and provisions for doubtful receivables, significantly impacting the REIT’s financial performance. The uncertainty surrounding the tenant’s ability to meet rent obligations has raised concerns about the stability of rental income from these assets, with analysts expecting that Keppel DC REIT may eventually need to replace the tenant.

Additionally, the financial outlook for Keppel DC REIT is further clouded by potential devaluation risks if the master leases at these properties are terminated. While the valuation for these assets was not impaired in FY2023, there remains a high likelihood of future devaluation, adding another layer of risk for investors. The REIT’s management is exploring options, including possibly divestment, which reflects the ongoing uncertainties. These challenges, combined with a significant jump in financing cost by about 24%, suggest that the REIT’s distributions and overall financial health may continue to face pressure. Therefore, until there is clearer visibility on resolving these issues, it may be prudent to avoid Keppel DC REIT.

2. Sabana REIT – shareholders’ revolution distracting management from their real work

Sabana REIT is currently embroiled in a prolonged struggle regarding the internalisation of its REIT manager, which has diverted significant resources and attention from its primary focus of asset optimization. This ongoing debate has necessitated various extraordinary general meetings and legal consultations, incurring substantial costs and creating a cloud of uncertainty over the REIT’s future management structure. Such distractions can have detrimental effects on both management’s ability to effectively oversee the portfolio operations, and hence investors’ confidence in the REIT’s stability and strategic direction. The time and resources spent on these issues could have been better allocated to enhancing property performance and exploring growth opportunities.

Moreover, while Sabana REIT’s properties have performed reasonably well, the continuous focus on internalisation and the associated costs are likely to impact its financial performance in the short and longer term. Given these concerns, it may be prudent to avoid Sabana REIT for now, especially since there are more than a handful of credible industrial REITs in Singapore. These alternatives offer robust operational management and are less likely to face the same level of corporate governance challenges currently plaguing Sabana REIT. Investors should consider these factors and exercise caution before committing to Sabana REIT amidst its ongoing internalisation saga.

3. Paragon REIT – Financing Risk + Low Growth = Uncertainties ahead

Paragon REIT, despite being a prominent luxury retail landlord with a strong position in Singapore’s market, faces significant financial challenges that warrant caution. One of the primary concerns currently is its debt profile and the impending refinancing needs in 2024. A massive 30% of its debt is up for renewal at a time when interest rates are still high. $300 million in perpetual bonds set to reset in August 2024. If these bonds are allowed to reset, the interest cost will jump to a massive 6%. Although management plans to refinance these bonds with bank loans, there is uncertainty over the new interest rates, which could still be higher than the current 4.1% for the perpetual bonds. The average cost of debt for Paragon REIT has already increased from 4.30% to 4.57% in the first quarter of 2024, indicating a potential strain on its financials.

Additionally, while the occupancy rate of Paragon REIT’s portfolio remains strong at 98.1%, with Singapore malls boasting full occupancy, the growth potential is rather limited. Only 4% to 9% of the leases for its Singapore assets are up for renewal in 2024, which limits the rental reversion potential. This is particularly concerning given the increasing financing cost environment. While Orchard retail is recovering, the pace is slow and unlikely to keep up with rising interest rates. These factors, combined with the uncertainty surrounding the refinancing of the perpetual bonds and the low growth prospects for its assets, suggest that Paragon REIT may face financial pressures in the near term. Thus, it may be prudent to avoid Paragon REIT until there is greater clarity and stability in its financial outlook.

Easy Replacements? REIT Heavy-weights to the Rescue

1. Mapletree Industrial Trust

Mapletree Industrial Trust offers a balanced mix of data centers and industrial properties, making it a suitable alternative to both Keppel DC REIT and Sabana REIT. Mapletree Industrial Trust has about 55% of its assets in data centers, with operational results more stable than Keppel DC REIT. Additionally, its Singapore-focused industrial properties are highly diversified and of higher quality than Sabana REIT’s.

Mapletree Industrial Trust’s robust portfolio with high occupancy rates and steady income from long-term leases ensures resilience. The REIT’s proactive acquisition and redevelopment strategies further enhance its growth potential. With a solid track record and a well-managed portfolio, Mapletree Industrial Trust provides a safer investment option for those looking to avoid the risks associated with Keppel DC REIT and Sabana REIT. In addition, its current high yield of 6.1% is higher than Keppel DC REIT’s 5.0% yield, and is a good trade-off yield vis-a-vis Sabana REIT’s 7.7% for a blue chip REIT like Mapletree Industrial Trust. 

Investors who prefer an even more stable alternative can look to CapitaLand Ascendas REIT, which I recently reviewed in an earlier post.

2. CapitaLand Ascott Trust:

Viewers of ‘The Dividend Uncle’ will know that CapitaLand Ascott Trust is one of my favourite REITs. It has shown strong operational performance, making it an attractive option for investors. In Q1 2024, the trust reported a 15% year-over-year growth in gross profit, driven by stronger operating performance and contributions from new properties. Even excluding acquisitions and divestments, gross profit rose by 7% on a same-store basis.

The trust’s diverse portfolio, which includes long-term stay properties like student accommodation in the US and rental housing in Japan, provides stability and resilience against economic downturns. Additionally, the trust’s properties in key gateway cities have benefited from high demand, partly driven by notable events like Taylor Swift’s concert tour. CapitaLand Ascott Trust can effectively replace Paragon REIT since they are both highly dependent on tourism. In addition, CapitaLand Ascott Trust’s 7.2% yield trumps Paragon REIT’s 5.9% easily. Investors can rest assured that we are getting higher returns even with higher quality.

Investors who prefer a retail REIT can definitely look to Frasers Centrepoint Trust for an equally stable proposition.

The Dividend Uncle’s Take: Blue-Chip REITs Offer Superior Risk-Reward Profile At Current State of the Cycle

Traditionally, blue-chip REITs have been highly regarded for their superior quality and operational stability, albeit often offering lower yields compared to their smaller counterparts. Investors have been drawn to smaller REITs for their higher yield and growth potential, which presented attractive opportunities despite higher risks. However, the recent volatility in interest rate expectations has significantly impacted the prices of REITs across the board, creating a unique market scenario.

This period of fluctuating interest rates has caused the prices of many blue-chip REITs to drop to attractive levels. Consequently, these REITs now present a compelling risk-reward profile that surpasses that of smaller REITs. The combination of their inherent stability, high-quality assets, and now higher yields makes blue-chip REITs such as CapitaLand Ascott Trust, Mapletree Industrial Trust and CapitaLand Ascendas REIT, particularly enticing.

For long-term investors, this shift underscores the importance of focusing on quality and stability. Blue-chip REITs are now offering yields that rival those of smaller REITs, but with significantly lower risk, making them an excellent choice for a stable and potentially lucrative investment portfolio. This current market condition presents a unique opportunity to secure high returns from traditionally stable investments, highlighting the value of blue-chip REITs in today’s volatile environment.

That wraps up our discussion on the 3 REITs to avoid and the 2 solid alternatives to consider in May 2024. Remember to always do your due diligence and consider the long-term prospects of any investment. If you found this post helpful, please like, and share your thoughts in the comments below. Until next time, stay smart, stay invested, and keep building your knowledge with ‘The Dividend Uncle.’ Thank you for tuning in!