Complete guide to Singapore REITs
Complete guide to Singapore REITs
Singapore's REIT market has been hit by higher interest rates, but that headwind seems to be dissipating. Estimated reading time: 33 minutes
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If you’ve ever strolled along Singapore’s Marina Bay, you will have noticed the dozens of office towers that dominate the skyline. You may not know that many of these towers are owned by real estate investment trusts (“REITs”) that you can purchase directly on the Singapore Exchange.
The benefits of REITs is that they’re liquid, less volatile than stocks and also offer tax benefits compared to owning stocks.
Since 2022, Singapore’s REIT market has performed poorly. The iEdge S-REIT Leaders Index is down roughly 30% from its 2019 peak despite the fact that Singapore remains one of Asia’s most dynamic economies.
The main reason for this poor performance is the current high interest rate environment. But now that the Federal Reserve is turning dovish, it’s possible that global interest rates will finally start coming down.
In this post, I will dig into the Singapore REIT (“S-REIT”) market, explain how it functions and also discuss the longer-term outlook for some of the 42 REITs listed on the Singapore Exchange.
Table of contents
1. How Singapore REITs work
2. Picking the right REIT
2.1. Sector exposure
2.2. High-quality assets
2.3. Decent sponsor
2.4. Low gearing ratio
2.5. Low valuation
3. The S-REIT market in mid-2024
4. The investable universe of REITs
4.1. Office
4.2. Retail
4.3. Hospitality
4.4. Industrial
4.5. Data center
4.6. Health care
4.7. Diversified REITs
5. Conclusions1. How Singapore REITs work
The first real estate investment trust (“REIT”) ever created was the American Realty Trust in 1961. This vehicle enabled investors to pool their resources to buy income-producing properties.
In Asia, it was only in the late 1990s that regulation was introduced to allow for a local REIT industry － first in Japan and then in Singapore.
In 2002, the CapitalMall Trust made a splash as the first REIT in Singapore. It was seeded with three shopping malls, including the Funan IT Mall close to City Hall. And in the following five years, a whopping 20 REITs were listed on the Singapore Exchange, becoming the hottest new asset class.
While the popularity of REITs has cooled down a bit, they remain a focal point for local investors seeking high-yielding assets.
Today, Singapore has the second largest REIT market in Asia, 42 REITs listed and with an aggregate market cap of US$72 billion.
So what is a REIT? An equity REIT holds a portfolio of income-generating property assets, say office towers in Marina Bay. Over 90% of the income from these properties are paid out as dividends to investors, and as long as that’s the case, the income is not subject to any corporate tax.
The terminology in the Singapore REIT market is different than for stocks, and also differs from the language used in the US REIT market. Shares in a REIT are called units and investors are called unitholders. Dividends are called distributions. And dividends per share are called distribution per unit, or “DPU”.
For American REITs, the key metric to track is the Funds from Operations (“FFO”). But in Singapore, REITs will disclose a metric known as Net Property Income (“NPI”), which is defined as the rental income after all operating expenses but before financing costs:
Net Property Income ("NPI") = Gross Revenue - Operating ExpensesUnder Singapore law, REITs are not allowed to engage in property development. In the past, a maximum of 10% of the asset value could be invested in “greenfield” (=new) projects. Today, if you include redevelopment of existing properties, then the limit goes up another 15 percentage points to 25%.
But still, these limits mean that organic growth is hard to come by. The only way that REITs can really grow is through acquisitions, which can be costly since they’ll be forced to issue new units or take on further debt.
The largest REIT markets in the Asia-Pacific include Japan and Australia. Newer REIT markets include Malaysia, Taiwan and more recently even India, the Philippines and China.
Most of Singapore REITs have at least some international exposure. Part of the reason is that the local property market is small. 70% of Singapore’s Central Business District Grade A office stock is already owned by REITs and developers, so local REITs have been forced to look abroad for growth. That is not the case in other REIT markets.
Unlike in the United States and Australia, however, Singapore REITs tend to be managed by external parties such as Keppel Land or CapitaLand. These sponsors tend to own 20-30% of the REITs themselves, and also help with managing the assets and making acquisitions on their behalf.
Managing an asset is straightforward. The sponsors will lease out properties to tenants, do marketing events and promotions, and also take care of the physical property through maintenance. In some cases, they’ll undertake “asset enhancement initiatives”, which is a fancy way of saying refurbishment of an old building to improve rents. A typical fee for such services would be about 3% of gross revenue on top of extra fees for the CEO’s office.
Sponsors will also help the REITs identify new investments, arrange financing, etc. Typical acquisition fees are around 1% and divestment fees can be additional 0.5%. Technically, the advisory services will be done in a separate entity from the manager, but in almost all cases, they belong to the same entity.
Finally, you have the so-called trustees, who act on behalf of unit holders and safeguard their interests. They make sure that the property deeds are accurate and the rentals enforceable, charging another 0.1% of the asset value for this service.
If you think this structure is unnecessarily complex, I tend to agree with you. But it’s to safeguard the interests of unitholders in a structure where an external manager has its own incentives to grow the asset base and the fee income it can derive from it.
Unitholders are protected by laws that restrict the power of the sponsor. Any transaction above 5% of net asset value has to be approved by unitholders. Managers can be removed with a simple majority vote. Valuations of the assets are also done externally every year through an independent third party to make sure the values are fair.
Okay, so why would anyone buy a REIT? In my view, the main attractions are that:
They’re a liquid and straightforward way to gain exposure to real estate assets with minimal transaction costs.
They tend to have lower volatility than the market as a whole, with an overall market beta of 0.64x. Though be aware of highly leveraged REITs as they may be forced to issue new shares at rock-bottom prices. It’s happened before.
Some investors have a preference for high yielding assets, perhaps in an effort to meet periodic cash obligations.
There are tax benefits. Singapore REITs that pay out more than 90% of their income do not have to pay corporate tax. Singapore residents who receive distributions from a REIT are not subject to any tax, whereas rental income from a fully owned property is. Meanwhile, non-resident unitholders currently enjoy a concessionary withholding tax rate of just 10%.
Given the fact that they offer high and stable yields, they’re frequently seen as bond proxies whose value fluctuate with the overall interest rate environment.
On the other hand, with external management, there are clear conflicts of interest and the layers of fees that some view as excessive. There’s also limited scope for growth when REITs are unable to grow organically through property development.
But some REITs are definitely better managed than others, and I’ll now discuss how to identify those.
2. Picking the right REIT
2.1. Sector exposure
The types of REITs on offer include retail (shopping malls), hospitality (hotels), offices, industrial properties, data centers and healthcare (hospitals). There are also a number of diversified REITs which own a variety of assets, frequently because those assets are mixed developments with both retail and office space within the same building.
The market is evenly divided between these categories, except healthcare and data center REITs, which remain more niche due to the limited supply of such properties:
You can also acquire diversified exposure through S-REIT ETFs such as the Lion-Phillip S-REIT ETF (SREITS SP - US$324 million) and the CSOP iEdge S-REIT Leaders Index ETF (SRU SP - US$52 million) which provide broad exposure to a range of REITs. Though bear in mind that they add additional fees, charging about 60 basis points annually for the service.
So which sector exposure is better? It depends on the outlook for each sector, and the extent to which the underlying assets are of high quality or not.
2.2. High-quality assets
In my view, a REIT should own assets that are irreplaceable and highly sought after by tenants.
Several factors go into the calculus. For example, an asset might have a great location, say, in close proximity to certain landmarks. A shopping mall might have a reputation, for example as Lucky Plaza has in the Filipino community. The overall ambiance might add to the attractiveness of an asset. Proximity to public transport helps. The vintage of the asset is also important, since it’ll require less maintenance capex to remain modern. And an attractive anchor tenant can also improve the status of a property.
One way to quantify the quality of an asset is by looking at the tenant turnover. If tenants are rapidly churning, that might mean they don’t value what the property brings to the table. A high overall occupancy rate means that it’s easy to find tenants. And finally, stable or rising rents suggest that tenants are willing to pay up for the space.
2.2. Positive supply & demand outlook
Properties are commodities. For example, a floor in an office building can easily be replaced by another. So, even trophy assets can and will be affected by fluctuations in the supply and demand for a particular asset class.
On the demand side, there’s often a secular trend overlayed by cyclical forces. That’s especially true for office and industrial real estate, whose tenants will suffer in recessions and can be easily substituted whenever contracts run out.
Meanwhile, the supply will depend on the animal spirits of investors. If the replacement cost of an asset is lower than transacted prices, developers will be tempted to build more, causing potential oversupply 3-4 years down the line.
Tracking coincident indicators such as vacancy rates, spot rents and tenant profitability can help spot longer-term trends. Then you can also look at leading indicators such the yearly new supply coming online compared to historical levels. If the net take-up doesn’t absorb all that new supply, then rents will have to fall.
2.3. Decent sponsor
As I mentioned earlier, Singapore REITs are special in that they’re all externally managed. That introduces a conflict of interest since the external manager will have an incentive to grow the asset base and collect transaction fees as well as a larger base for future management fees.
The extent to which sponsors “play the game” differs greatly. Some sponsors truly do care about unitholders, being reluctant to engage in yield destructive acquisitions. High-quality sponsors can also engage in asset enhancement initiatives, especially in retail REITs where the upside in yields from refurbishment can be substantial.
I suggest looking at the track record of a particular sponsor across all the REITs that it manages. Behavioral patterns tend to repeat. You can look at the historical share dilution. I tend to prefer little to no dilution at all. You can look at whether the acquisitions have been done at attractive cap rates - unlikely, but it’s possible. You can also look at the trends in the distribution per unit and net asset value per unit. Ideally, they should go up over time. Just be mindful that in Singapore, properties are accounted for at fair value. So, a rising net asset value per share can also be due to a boom or even a bubble in a particular class of property, causing rising prices for comparable transactions to drive up fair value estimates. Trends in the distribution per unit should be more reliable in assessing whether a sponsor is shareholder-friendly or not.
2.4. Low gearing ratio
Under Singapore law, a REIT is unable to take on more than 45% gearing (=leverage), which is defined as total borrowing divided by total assets. Most REITs are below this limit at a 38% average. But some are getting close to it. That makes S-REITs different from, say, Japan and the United States, where such gearing limits do not exist.
The Monetary Authority of Singapore recently proposed to increase the limit to 50% along with minimum interest coverage ratios of 1.5 times.
On the surface, the 45% gearing ratio limit doesn’t seem excessive. Properties are perfect for adding on leverage since banks tend to feel comfortable with them as collateral. However, the 50% gearing limit makes it difficult for REITs to compete with private equity companies to acquire assets. And with less leverage, returns to unitholders will be lower.
The other problem has to do with reflexivity. If a REIT hits its gearing ratio, it may be forced to deleverage by issuing shares at the wrong moment. That’s exactly what happened during the Great Financial Crisis of 2008, when the overall Singapore REIT index dropped by 75%. Many of the REITs were leveraged going into the crisis, with several hitting the regulatory limit and being forced to deleverage as fair values came down with lower market prices. A
In other words, high leverage, therefore, introduces reflexivity, with low prices potentially begetting even lower prices if a REIT is forced to raise equity in a crisis. REITs in Australia and Japan are less likely to suffer this fate since they’re not constrained by gearing limits.
But even if you disregard the risk of exceeding gearing limits, studies have shown that REITs with lower leverage tend to outperform. So I would make sure that the interest coverage ratio exceeds, say, 3x and that the gearing ratio does not exceed, say, 40%. You can also look at credit ratings to understand how vulnerable a REIT is to, say, interest rate movements or currency movements if the debt is denominated in a different currency than the assets.
2.5. Low valuation
In theory, you can value a REIT using discounted cash flow analysis (“DCFs”). But in a DCF, the assumptions can swing the target price massively. And who is to say that a discount rate of 5% or 8% is appropriate for any given REIT?
In the United States, many investors focus on price/fund from operation (P/FFO), which is net income excluding depreciation. In Singapore, on the other hand, since REITs pay out more than 90% of their income, investors typically use the distribution yield, or trading yield, as a heuristic to value REITs.
REIT investors will typically demand a premium to government bond yields to account for the risk of vacancies and fluctuations in rents. In the United States, the yield spread to the 10-year government bond has historically been around 2.6 percentage points. In Singapore, the 10-year government bond yield is currently 2.7%, which means that investors should probably require REITs to trade at somewhere above 5.3% yield.
Trading yields can be misleading if rents are above current spot market rents, which will then inevitably lead to lower rents in the future. This phenomenon is known as “negative rental reversion”. Trading yields can also be misleading if a REIT is highly indebted or about to lose a major tenant.
You can also look at net asset values. Since properties are valued at fair values based on comparable transactions, the Price/Book of a particular REIT will reflect the discount to recent transacted values. However, since they rarely buy back shares or divest assets, there’s nothing that says that a REIT will necessarily rise to 1.0x book. Meanwhile, a low price/book means that it will be more difficult for the REIT to grow through yield-accretive acquisitions.
Finally, you can look at the replacement cost of a set of buildings. Look at land values, the construction cost, interest expense and developer profits to understand whether the properties owned by a REIT are undervalued. I think such analysis is particularly important in inflationary environments when construction costs are rising rapidly.
Since growth is hard to come, normalized yields is what truly matters. And to understand normalized rents, we need to make estimates of where rents are going and then capitalize them at a cap rate somewhere north of the 10-year government bond yield. That’s the approach that I personally favor.
3. The S-REIT market in mid-2024
Singapore’s monetary policy is linked to that of the United States through its managed float currency system. The Singapore Dollar is allowed to fluctuate in a narrow band against a basket of currencies, of which the US Dollar is the most important. That means that if US interest rates rise, Singapore will need to follow suit to avoid unwanted currency depreciation.
That’s exactly what’s happened in the past two years. As the Fed Funds rate rose from zero to 5.25%, Singapore’s short-term rates have risen to 3.6%. These higher rates have caused the value of Singapore government bonds to decline. And bond proxies such as real estate investment trusts have also suffered.
The are two reasons why REIT prices have dropped. First, the valuations of underlying properties tend to decline as property becomes less attractive compared to bonds. Second, REIT interest payments will go up, causing distributable cash flow to decline.
Singapore’s broader REIT indices are down about 25% since 2019. And the underperformance is even greater if you compare it to Singapore’s Straits Times Index.
If you compare the valuation levels with book values, which are derived from fair value estimates, Singapore REITs now trade at a 17% forward discount － an unusual situation in a historical perspective:
The yield spread against the 10-year government bond yield is currently about 3.5%, slightly below the average. So rate cuts have to some extent already been priced-in.
The absolute trading yield of about 6% is in line with the historical numbers, as you can tell from the chart above. But on a sector basis, office REITs are trading at a high yield of 7.7% while the other sectors are trading more in line with their historical levels.
So why are office REITs yielding this much? Because the office vacancy rate has gone up, spot rents are now down and investors are expecting negative rental reversions. Meanwhile, retail rents have improved thanks to greater tourism to Singapore. And factory / warehouse rents have held up better than expected.
Let’s now dig into the drivers for each of the S-REIT sectors one by one.
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4. The investable universe of REITs
4.1. Office
