AP-REITs: Resilience amid strong fundamentals

Asia-Pacific real estate investment trusts (AP REITs) rebounded in 2021 after a difficult 2020. Regional economies reopened at different speeds as mobility and travel restrictions were gradually reduced. Thanks to continued robust fiscal and monetary policies, all regional economies were able to emerge from recession. 

The situation in Hong Kong has improved due to tight border controls, and tenant sales have shown a healthy recovery boosted by the issue of consumption vouchers. In Singapore, a high vaccination rate of 88% has been instrumental in boosting consumer confidence.

However, the situation remains fluid, as the emergence of the Omicron variant has led Singapore and Thailand to tighten quarantine-free travel. Elsewhere, some territories have reinstated mobility restrictions. 

Let’s take a deeper dive into various dynamics for AP REITs. 

From a real estate segment perspective, rental support measures and relief have remained well contained versus 2020. We saw retail landlords guiding toward a stabilization in rental reversion trends with further improvements expected as we move into 2022.

The global industrial and warehousing sector stands out in terms of low vacancy rates and cash flow resilience. Capital values have continued to appreciate over the past six months due to strong demand for the asset class.

Despite border closures and higher interest rates, cap rates (rate of expected yield) for Australia logistics assets have also compressed due to active transactions. Given tight vacancy rates in Australia, rental rates are improving, further enhancing the market’s capital allocation attributes.

From an asset class perspective, investors need to remember that dividend returns remain an essential feature of REITs and that dividend return has remained positive regardless of the market environment. In times of market drawdowns, dividends help compensate for any losses; when markets move higher, dividend augments total return. Over the past 10 years, dividend return has made up over half of the total return for AP REITs.¹

Even in 2020, when the impact of COVID-19 was deemed to be at its greatest, dividend returns from REITs were positive, underpinned by office and industrial REITs that enjoyed high rental collection rates. 

Asia REITs (ex-Japan) outperformed broad market and real estate stocks in 2021 with lower volatility (index level rebased at 100)

Asia REITs (ex-Japan) dividend recovery poised to continue in 2022 (index dividend value)  

Overall, we saw 2021 as a year of recovery for dividends. This is likely to continue going into 2022, as rental holidays end and occupancy rates improve, augmented by full-year dividend contribution from new acquisitions done in the past year. Meanwhile, 2021 dividend estimates have recovered by 24% from their low point in October 2020 while estimates for 2022 have recovered by 17% to 18%. Notably, both estimates are above the highs seen at the beginning of 2020.  

2022: recovery amid a fluid situation

As we look ahead to 2022, there are several reasons to be optimistic about the global recovery. 

With higher global vaccination rates, the economic risk of the pandemic is likely to fade; however, this will depend on the trajectory of the Omicron variant. Compared with a year ago, governments now have more solutions to help fight the pandemic such as booster rollouts and effective antiviral drugs. 

Key markets such as Singapore and Australia have achieved high vaccination rates and began reopening borders in the fourth quarter of 2021. Yet Hong Kong’s vaccination rate remains comparatively low (especially among the elderly), and the city isn’t expected to relax its border controls until 2022.

As more territories accept COVID-19 as being endemic in nature, there should be an end to disruptive lockdowns or tightening. Consequently, rental support and relief may become considerably lower on a year-over-year basis.

Transactions support capital values

Despite COVID-19-related disruptions in 2021, we continue to see healthy transactions in Asia’s commercial real estate market that will support capital values. 2022 may be a year when we see a more globally synchronized reopening of borders, with the most tightly controlled, China, looking at a potential border reopening in 2022. We believe there will be greater confidence regarding travel and the resumption of cross-border business activities such as leasing negotiations and due diligence relating to asset acquisitions. 

Of course, this assumes no further deterioration in the COVID-19 situation.

Industrial segment and reopening plays may benefit in 2022

Healthy demand in the industrial and warehousing sector should continue. This has already reduced vacancy rates in major markets to low levels. We believe the strong rental growth trend could be an additional performance driver.  

Reopening plays remain attractive, as we anticipate a synchronized loosening of global borders. In particular, city and discretionary malls have been operating below pre-COVID-19 levels due to the shift toward work from home and limited leisure travel. As such, they can offer more recovery upside in 2022. 

Inflation remains a concern, but fundamentals are healthy

In mid-2021, global inflationary pressures began to build. As a result, we saw heightened volatility in the share prices of REITs due to stagflation fears. Recent inflationary data has been robust due to higher oil prices, supply chain disruptions, and a strong recovery in demand. However, in recent weeks, central banks such as the Bank of England have increased interest rates, and the U.S. Federal Reserve (Fed) has signaled the potential for up to three U.S. rate hikes in 2022. Our forecast remains on the dovish side, even though we’ve pulled forward our expectation of rate hikes; we have two rate hikes penciled in for the second half of 2022.   

Over the long term, our macro view hasn’t changed: We think that interest rates should remain lower for longer. Low rates have been supportive of real estate, in view of the comfortable income pickup buffer over the cost of borrowing. It has also helped REITs make accretive acquisitions as debt has remained affordable. 

We think that every tapering exercise is different, and the market’s reaction this time won’t be the same as before. To put things in perspective, the Fed cut rates to zero and has aggressively expanded its balance sheet in response to the COVID-19 pandemic. The U.S. economy is recovering strongly as the country reopens, and as such, it makes sense for the Fed to pull back from its quantitative easing policies. In this cycle, the Fed’s messaging has been more transparent than in 2013’s taper tantrum episode, and it appears that the market has priced in a lot of Fed hawkishness going into 2022. 

We continue to focus on the fundamentals of REITs, such as core earnings and cash flow resilience, strong capital management, and quality real estate to command better rental rates in times of economic recovery.

Conclusion

AP REITs are poised for a continued rebound in 2022 on the back of gradual economic reopening and a recovery in dividends. While the recent emergence of the Omicron variant may introduce greater uncertainty, the resilient fundamentals of the asset class should continue to support performance in the new year. 

1 Bloomberg, as of November 30, 2021. Asia ex-Japan REITs are represented by the FTSE EPRA/Nareit Asia ex-Japan REITs Index (U.S. dollars).