Staying positive on S-REITs.

In the recent weeks, shares of property developers, telecoms companies, commodities companies, shipping companies, gaming companies etc have mostly declined in price.

So, in a sea of red, is staying uninvested the way to go? Very probably, many are doing just that. Personally, I am staying invested and mostly in selected S-REITs. In an environment of greater volatility, S-REITs' unit prices have demonstrated resilience and my portfolio of S-REITs has remained relatively unscathed in the recent market weakness.

Some asked me if it is safe to invest in S-REITs now or add to their long positions. Truthfully, I cannot give any answer in the affirmative. I will ask you to instead consider the more discussed circumstances in which S-REITs could fail.

1. Interest rates suddenly shoot through the roof when the time comes for S-REITs to refinance.

2. Credit drying up, leading to S-REITs being unable to refinance at any price.

3. Tenants defaulting en-masse leading to S-REITs being unable to meet their financial obligations.

4. Value of properties declining to the point where gearing exceeds 40%.

Then, ask ourselves how likely are these events to take place in the next two years. I have given some thought to these points and I remain sanguine about the situation.

1. It is unlikely that interest rates would shoot through the roof overnight or over the next two years. We must see some pretty strong inflationary pressure before interest rates would go higher. U.S. interest rates being revised upwards by 0.25% every few months is hardly catastrophic. Unless funds are able to get higher returns with similar or lower risks elsewhere, I do not see S-REITs turning unattractive, all else remaining equal.

2. The Great Depression delivered a lesson which has not been forgotten if the actions by central banks around the world were anything to go by. Any businessman would know that credit is the lifeblood of the economy. Credit dries up, businesses come to a halt and great hardship would follow. Central banks will ensure that this never happens again. We came pretty close in the last great recession and already got a fleeting glimpse of what could happen if credit dried up completely.

3. The supply of industrial space is likely to remain tight in Singapore in the near future and I have blogged about this. If the economy takes a sudden turn for the worse, we could see some tenants defaulting but it is unlikely that tenants would default en-masse. Even in the last recession which was one of the worst I have seen, nothing that serious took place. With interest cover ratios of 5.7x or more, industrial S-REITs are not about to make me lose sleep at night.

4. Most S-REITs are conservatively geared. Even with a gearing level of 32%, we have to see property valuations dropping by some 20% before gearing would hit 40%. A 20% decline is pretty severe and I do not think it likely unless the current valuations are frothy. If we look at the current valuations of industrial properties S-REITs, they are still very much below the peak before the last recession.

Although I remain sanguine about the fundamentals of the S-REITs I am vested in, I do recognise that prices are driven by sentiments. If Mr. Market should go barking mad and is willing to sell to me at prices which would give me distribution yields in excess of 10% like it did in the last recession, I would gladly increase my long positions. Yes, that is my plan. Keep a warchest ready and seize the opportunity if it should present itself.

Related post:
Investing in REITs: A flawed strategy?