I received a very interesting question from a reader recently:
Thank you for your analysis of T-bills and REITs. I feel your analysis is grounded in reality as compared to other singaporean commentators who seem to be perpetually bullish, especially on when fed will start dropping rates.
I am curious, could you do an article on the Sreit leaders index? Forecast on where it will go in the next 2-3 years? I hold a significant position via syfe reit+ portfolio as i didnt want to dabble in individual reits. I should have pulled out when the interest rate hike started in late 2021 but i underestimated the drop on prices and am now sitting on a 10% loss.
Here is my view, what do you think?
- Fed rates will start coming down in h2 2024, if not later
- Dpus continue to be impacted as we have a high interest rate env for a few years now. Any refinance in the next 4 years will be at higher rates than before meaning we can expect debt to get costlier.
- Rentals have increased so there is some offset, but rentals in sg are already very high, they dont have much room to grow.
- There are some bright spots in sreit leaders index, but as an index it will still trend downwards for at least until 2024, then maybe range bound in 2025 and then start picking up in 2026. So its better to liquidate the reits position in sreit leaders index, and invest in specific reits u have analyzed… or just put it in sgbs..
What do you think?
What is the reader asking about REITs?
The more I thought about it – the more intrigued I got.
The reader is basically asking 3 questions:
- How will REIT prices play out over the next 2 – 3 years?
- What is the best way to invest in REITs for the next 2 – 3 years? Passive indexing or picking individual REITs?
- What could go wrong with investing in REITs now?
Obviously nobody has a crystal ball to answer this definitively.
But I figured I would share my views – and feel free to let me know if you disagree.
Basics: What is the S-REIT Leaders Index?
The iEdge S-REIT Leaders Index is a “free-float market capitalisation weighted index that measures the performance of the most liquid real estate investment trusts in Singapore in SGD.”
Basically, it’s an index of the blue chip REITs in Singapore.
Top 10 REITs are below, and its exactly as you would expect – CICT, Ascendas, MLT, MPACT etc:
Like the reader said – REIT prices peaked in late 2021 (before interest rates started going up).
REITs then bottomed out in late 2022 – followed by a small recovery in 1H 2023.
And recently it’s gone back down to 2022 levels again.
How will REIT prices play out over the next 2 – 3 years?
But that’s all in the past.
Where are REIT prices headed the next 3 years?
I’ve set out the reader views in bold below, and added on my comments.
Reader Thinks: 1. Fed rates will start coming down in h2 2024, if not later
After this week’s FOMC – market is pricing in exactly the reader’s view.
Interest rates to stay flat until 2H 2024, followed by 2 interest rate cuts in 2024.
You guys know me.
For much of this cycle – I have been banging on and on about how interest rates need to go higher and stay there longer than what is priced in.
All that has played out.
Today, market thinks we stay at 5.5% interest rates until 2H2024, with only 2 rate cuts in 2024.
And I’m not so sure I agree with that view.
I think over the next 12 months, the risk is for economic growth (and unemployment) surprising to the downside.
I think there is a real risk that interest rates need to get cut faster, and deeper than what the market is pricing in.
And I don’t think this has been priced into REITs.
Reader Thinks: 2. Dpus continue to be impacted as we have a high interest rate env for a few years now. Any refinance in the next 4 years will be at higher rates than before meaning we can expect debt to get costlier. 3. Rentals have increased so there is some offset, but rentals in sg are already very high, they dont have much room to grow.
This statement by the reader is not wrong.
But this is also one of the biggest points that new investors get wrong.
You never look at the absolute level, you look at the rate of change.
This applies to earnings, it applies to economic growth, and it applies to interest rates.
Imagine that you are driving a car.
Market doesn’t really care what is the speed of the car.
It cares about how quickly the car is accelerating, or decelerating.
Now imagine that in 2024 the Feds instead of raising 75 bps a meeting, they are cutting 75 bps a meeting.
That could be very bullish for REITs from an interest rate perspective.
So it doesn’t really matter what level interest rates are at – if they are dropping quick enough, the market will price that in.
Reader Thinks: 4. There are some bright spots in sreit leaders index, but as an index it will still trend downwards for at least until 2024, then maybe range bound in 2025 and then start picking up in 2026. So its better to liquidate the reits position in sreit leaders index, and invest in specific reits u have analyzed… or just put it in sgbs..
Again, predicting moves with a high level of certainty is a fools errand.
You want to have a view, but you trade based off risk-reward.
It’s not so much about whether you are right or wrong.
It’s about how much you make when you are right, vs how much you lose when you are wrong.
But I don’t want to talk in riddles all the time, so let me answer this question straight.
My view, is that REITs will trade rangebound (or in a downtrend) until the Feds start cutting interest rates.
Once the Feds start cutting, the impact on REITs will depend on (a) why the Feds are cutting, and (b) how quickly they cut.
If Feds cut because of a bad recession, REITs won’t bottom until the economy starts to improve.
If Feds cut because inflation comes down and there is no recession, that could be the bottom for REITs right there (depending on how quickly they cut).
So… Buy REITs now or not?
If you recall, I was pretty bearish on REITs for most of 2022.
To me, investors were underestimating the impact of interest rates on (a) interest expense costs, and (b) property values.
All that has played out.
All the arguments I made last year, I see them parroted around in mainstream media today.
To the point where I would say much of these risks are priced in.
Markets are pricing in rates to stay high in 2024, with only 2 rate cuts.
And the way I see it – interest rate risk over the next 12 months is tilted to the downside. And current valuations are pretty juicy.
So I’m actually more bullish REITs today than I was last year.
What is the best way to invest in REITs for the next 2 – 3 years? Passive indexing or picking individual REITs?
Next question – index or pick individual names?
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Passive REIT Investing – Buy the S-REIT Leaders Index (5%+ dividend yield)
The reader went down the passive path with Syfe REIT (tracking S-REIT Leaders Index).
This gave him broad exposure to the blue chip REITs in Singapore.
Blue chip REITs have not been as hard hit as the small-mid cap REITs – and this shows.
You’re looking at 20% declines for the index, vs about 40% declines for the small-mid cap REITs.
On the flipside though.
This also means that if conditions start to improve, you won’t see as big of a recovery.
So it really goes back to what you want.
Are you more concerned about not losing money if you’re wrong? In which case blue chips are probably safer due to the stronger balance sheet.
Or are you more concerned about making more money if you’re right? In which case the small-mid cap REITs probably offer greater upside because they are so beaten down.
Active REIT Investing – $100,000 at 7% dividend yield
If you gave me $100,000 and forced me to buy REITs today?
I’ll probably stock pick individual names.
Personally, I think the small-mid cap REITs offer better value now.
You’re looking at around 6-8% dividend yields, and most of these names are down 40-50% from highs which means they have more room to go up if there is a recovery.
Gun to my head, I might go with something like the following (not financial advice):
- Lendlease REIT (which I just did a deep dive on last week)– 8.1% yield
- Starhill REIT – 7.7% yield
- Keppel REIT – 6.6% yield
- MPACT (but HK play) – 5.8% yield
Assuming you equal weight them – that’s a 7.05% dividend yield that you are paid to wait for the next phase of interest rate cuts. And if (when) interest rates get cut, there could be pretty nice capital gains as well.
Whereas the S-REIT Leaders Index has a trailing dividend yield of 4.0%, but today you’re probably looking at 5ish% dividend yield.
So personally I prefer picking individual REITs here, but it’s really a personal call.
I’ll be updating the FH REIT watchlist this weekend with the list of REITs that I am keen to buy (with rough target pricing), so do sign up if you are keen.
Given this is not the bottom, you have to pick quality names and position size well, and look to hold for a 2 – 3 year horizon at least.
What could go wrong with investing in REITs now?
I just want to be absolutely clear though.
Even if my analysis above holds true.
This is probably NOT the bottom for REITs.
REITs are unlikely to have a sustained recovery until interest rates start going down meaningfully.
Why is this not the bottom for REITs?
Let’s game out the different ways that economic growth and inflation can play out in the next 12 – 18 months.
They can basically be split as follows:
Only Scenario 2 is outrightly good for REITs – economic growth stays strong, and inflation miraculously drops to 2%.
This allows the Feds to cut interest rates rapidly, without a recession.
But c’mon, how likely is that to happen?
More likely is Scenario 1 or Scenario 3/4.
Scenario 1 – What market is pricing in
Scenario 1 is basically what is priced into markets today.
Economic growth stays strong, inflation stays strong.
Meaning we only get 2 interest rate cuts in 2024.
This is probably not pretty for REITs, and is roughly what is priced in today.
Which implies upside for REITs if the market is wrong on this.
Scenario 3 / 4 – the more likely outcome?
This is probably the more likely outcome.
Economic growth starts to weaken going forward.
Inflation comes down, but still remains around the 3% range.
In this scenario much will depend on what the Feds do.
And really, the jury is still out on that one.
Powell may talk tough about inflation today – but if the economy weakens, and unemployment ticks up.
He may sing a very different tune in an election year.
When rate cuts?
Historically speaking, the longest Fed “Pause” over the past 30 years lasted only 12 months.
While the longest “soft landing” pause only lasted 7 months.
Reason being that to truly achieve a “soft landing”, Feds need to act proactively and cut rates at the first sign of slowing growth.
The longer they hold rates high, the higher the chance of a hard landing style recession.
Assuming July’s FOMC was the last rate hike for the cycle, you might need to see rate cuts as early as 1H2024 to truly achieve a soft landing.
Sure, you may argue this cycle is different because of fiscal stimulus, fixed rates, strong consumer etc, and that’s definitely possible.
But history is not on the side of the Feds here.
So… why bother buying REITs now?
Which raises the question – why even bother buying REITs now, given all the uncertainty?
Why not just wait until the Feds start cutting, and then buy then?
I guess 2 points:
- Individual REITs may bottom out before the index as a whole
- I could be completely wrong on my analysis above
So while I don’t think REITs as a whole have bottomed out just yet from a macro perspective.
From a micro perspective – there are a lot of single name REITs that:
- Hold high quality properties
- Trading at prices down 40-50% from highs (some at COVID lows or worse)
- Paying 7-8% dividend yields
- Decent balance sheet
That’s attractive enough that I don’t mind buying some REITs here (while keeping enough cash to buy more down the road).
How much you make when you’re right, vs how much you lose when you’re wrong
I cannot repeat this enough.
In investing, it’s not about being right or wrong.
It’s how much you make when you’re right, vs how much you lose when you’re wrong.
Let’s put it this way:
Assume I have a 50% chance of making money on REIT X, if I buy today and hold for a 3 year timeframe.
If I am right, I make 40% (15% capital gains + 3 years worth of dividend).
If I am wrong, I lose 30% (40-50% capital loss, offset by 3 years dividend).
You’ll probably agree these are very, very conservative numbers.
And Kelly Criterion (a method for sizing investments) says I can go ahead and bet 41% of my portfolio on this.
For obvious reasons the numbers above are approximate, and I would not be putting 41% of my portfolio into REITs today given my analysis above.
But the point is still clear.
This is a favourable trade that can be made, as long as you position size well, and recognise that you could be wrong (so don’t put money you cannot afford to lose).
So this isn’t the bottom, but prices are attractive enough that I am slowly accumulating.
But I can’t stress this enough – focus on quality properties with strong sponsors / balance sheets.
And position size well – you dont know exactly how the next 12 months is going to play out.
With the latest FOMC promising interest rates to stay higher for longer, we’ve had a further sell-off in REITs that are exposing very interesting prices across the board.
I’ve shared above some of the REITs that look interesting to me and that I may add in the months ahead – but I will be refreshing the REIT (and stock) watchlist this weekend for Patreons to take into account latest pricing.
Patreons will also have full access to my positions, and how much of my portfolio I am allocating to REITs.
This article was written on 22 Sep 2023 and will not be updated going forward. For my latest up to date views on markets, my personal REIT and Stock Watchlist, and my personal portfolio positioning, do sign up as a Patreon.
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