Singapore’s real estate investment trusts (REITs) have been favoured as they pay consistent dividends and recorded strong historical returns.
REITs can be further split into different sub-sectors, each having their strengths and weaknesses.
Office REITs stood out by having the highest dividend yield every month of 2023, ranging between 8.9% to 10.0%.
In comparison, other segments averaged around 5% to 6%.
We examine why this is the case and whether it justifies owning more office REITs.
Artificially-inflated distribution yields
A REIT’s distribution yield is calculated by dividing the annual distribution per unit by the unit price.
The formula implies that a lower unit price can artificially inflate the trailing 12-month distribution yield of a REIT, without requiring the distributions paid out to be particularly high.
This was what happened to office REITs as their unit prices fell by an average of 10.5% on a year-to-date basis.
For January year, half of the REITs that saw the highest net outflows by institutional investors were office REITs.
The high selling volume by professionally-managed funds sows doubt about whether office REITs are still worth purchasing despite their alluring yields.
So, what contributed to the sell off?
Mass layoffs
One critical reason is the Great Layoff led by the technology sector.
Over a hundred thousand employees were let go last year, signalling further retrenchments into 2023.
Elsewhere, layoffs have also been recorded across other sectors such as automotive and recruitment firms.
Even though mass firing was most acute in the US, Singapore workers have not been spared either.
Since office REITs have large exposures in Singapore and the US, corporate downsizing is highly relevant as it increases the vacancy rates of offices.
In light of this, it is worthwhile to pay attention to tenant concentration.
Office REITs provide information about their top ten tenants.
Those with high exposure to the US, as well as the technology and banking sectors, may be at higher risk.
Keppel Pacific Oak US REIT (SGX: CMOU) listed Meta Platforms, Inc. (NASDAQ: META) as its fifth largest tenant by cash rental income.
Aggressive headcount reduction of over 20,000 jobs announced by the social media giant may signal lower future occupancy rates.
Another example is Manulife US REIT (SGX: BTOU), where one of its top ten tenants is Amazon (NASDAQ: AMZN).
Similarly, the e-commerce behemoth also fired upwards of 20,000 employees.
Regardless of whether companies engaged in mass layoffs, the introduction of work from home and hybrid work by the pandemic has made return to office policies difficult to enforce.
Another cause of concern is rising interest rates which lead to reduced portfolio valuations.
Some office REITs, such as Prime US REIT (SGX: OXMU), even experienced declining value across all its property assets.
Signs of a supply glut in rental spaces prompted some tenants to sublease their prime locations to other companies.
A final nail in the coffin was the collapse of regional US banks such as Silicon Valley Bank which led to tightening credit conditions.
This shocking event puts further pressure on highly-levered REITs as lenders grow more cautious on who they lend to.
Impact on operational metrics
Qualitative headwinds affect various office REITs differently.
Comparing quantifiable metrics across office REITs with US exposure helps investors to gauge the varying magnitude of these challenges.
We start off with occupancy rates.
Keppel Pacific Oak has the highest occupancy rate at 92.6%.
The weighted average lease expiry (WALE) paints a more dynamic picture as longer WALEs typically result in lower vacancy risk since rental contracts go on longer before they need to be renewed.
We observe that despite having the lowest occupancy rate at 88.0%, Manulife US REIT has the longest WALE at 4.7 years, whereas Keppel Pacific Oak US REIT has the shortest WALE at 3.4 years.
To avoid tenant concentration, we zoom in on the WALE of the REITs’ top 10 tenants.
Doing so revealed that Keppel Pacific Oak has, interestingly, the lengthiest WALE among its largest occupants at 4.7 years despite having the shortest overall WALE.
For dividend-focused investors, looking at distribution per unit (DPU) instead of dividend yield helps them to screen out the effects of underlying share price movements.
From this angle, Prime US REIT offers the highest DPU at US$0.0655 per share.
What investors care about
Increasingly, commercial real estate investors are prioritising income stability.
The potential for rent hikes and a steady stream of rental income were two top factors when investors evaluate opportunities.
Rent reversion, which refers to periodic movements in base rent, serves as one such indicator.
Prime US REIT outshone Keppel Pacific Oak and Manulife US REIT, registering a rental reversion of 11.4% against 3.8% and 0.7%, respectively.
Get Smart: Make sense of the numbers
The quantitative metrics listed above are by no means exhaustive.
Other items to consider include net lettable area, distributable income, gearing ratio etc.
As touched on previously, the attractive dividend yields of office REITs may simply be skewed by their falling share prices.
In fact, the absolute DPU offered by some office REITs had actually fallen due to higher finance expenses and higher expected vacancy rates going forward.
There may also be a possibility of raising distributions to retain investors who considered selling office REITs due to headwinds discussed above.
Regardless, investors ought to conduct their own due diligence to determine if such investments continue to be worthwhile holding given the many moving parts of these office REITs can be affected differently by macroeconomic and industry factors.
Disclaimer: Tan Ke Xuan does not own shares in any of the companies mentioned.
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Disclosure: Tan Ke Xuan does not own shares in any of the companies mentioned.
