Regional REITS await dovish mood

Asia-Pacific real estate investment trusts (REITs) and landlords are still waiting for global interest and policy rates to go lower, Standard and Poors (S&P) Global Ratings said yesterday.

Commercial offices are the most vulnerable to high rates because this asset class is generally also suffering the most from supply-demand imbalances.

That’s according to a chartbook-style report we published today, titled “Asia-Pacific Real Estate: The Great Waiting Game.”

“Office assets will continue to bear the brunt of structural and cyclical challenges,” S&P Global Ratings credit analyst Simon Wong said.

“Asset valuations look set for further decline in major Australian cities and Hong Kong.”

Capital-management levers

In our view, rated landlords can use capital-management levers to improve credit metrics eroded by higher interest rates. Yet higher-for-longer rates could hurt their ability to execute in a timely manner. S&P Global Ratings expects US dollar interest rates to remain elevated through the remainder of 2024, and this could limit the ability of Asian central banks to ease monetary settings.

We also note that debt maturity profiles are shortening as landlords opt for bank loans over bonds. But in our view, financing risk is manageable due to covenant headroom. Banks remain supportive of prime commercial assets in key Asia-Pacific gateway cities.

Despite higher-for-longer rates, rated real estate companies are benefiting from solid economic growth momentum in a number of regions in Asia-Pacific. The net proportion of ratings on negative outlook has dropped to 9 percent from a peak of around 19 percent in August 2023.

“Resolution of the credit pressures for real estate companies hinges on timely execution of their capital management plans and/or delivering anticipated improvements in their operating performance,” Wong said.

The report covers conditions affecting rated office, retail and industrial REITs and landlords across the region, including Australia and Singapore.

Sector watch points over the next 12 months include: Further deterioration in valuations will increase gearing (debt to assets) and reduce covenant headroom; Perceived stabilization of capitalization rates could encourage capital inflows back into the sector. This in turn would support the balance sheet initiatives landlords are employing; Resilience of shopping centers in Australia will depend on population growth, tourism volumes and Stage 3 tax cuts. Headwinds of sustained inflationary cost-of-living pressures and weakening consumer confidence will dampen retail sales; Hong Kong’s weak domestic consumption continues as residents shop overseas and at nearby mainland China cities; and ongoing e-commerce penetration, low supply volumes and tight vacancy levels will continue to underscore favorable tenant demand and rental growth.