VIEWS FROM THE PEAK: The sweet spot between bonds and stocks

By Joey Cipres, AP Securities research analyst

The Bangko Sentral ng Pilipinas’ (BSP) rate cut cycle marked the beginning of a new bull market for the PSE, with the index surging by 11.4 percent to a high of 7,458.74 less than six weeks after the Monetary Board’s Aug. 15 meeting.

At the same time, average government bond yields dropped by 40 basis points (bps) from 6.57 percent to 6.02 percent during the same period. Bond yields are expected to go even lower as the BSP cuts rates further, which would make bonds less attractive compared to stocks.

We understand that bond investors have a different risk profile from stock market investors, so we do not expect everyone to just sell off their bonds and buy stocks.

The best of both worlds 

However, there exists an investment vehicle that is essentially a combination of the best of both worlds – regular payouts on your investment, alongside capital appreciation. We see them as the best entry point for investors looking to diversify away from bonds and into equities. 

These investment vehicles are called real estate investment trusts or REITs, and they are mandated by law to pay out at least 90 percent of their income as dividends. If a REIT does its business the right way, its shareholders should be assured of steady or even steadily increasing cash payouts from their REIT holdings.

Which REIT? 

So, where should you allocate? Given the numerous listed REITs in the market, there might be some confusion as to an investor’s proper allocation. With this, we have handpicked several names that we believe are worth paying attention to and have the greatest potential for capital appreciation on the back of falling rates moving forward.

Our top REIT picks are Robinsons Land’s RCR and Ayala Land’s AREIT, as both have demonstrated their ability to increase dividends through infusions of earnings-accretive properties, and have been able to maintain occupancy levels in their properties despite the headwinds for the property sector in recent years. 

Both REITs have also made moves to diversify their holdings away from the weaker office segment and started infusing malls, which stand to benefit from the expected pick-up in consumer demand as cooling inflation and real wage growth improve the purchasing power of consumers.

Joey Cipres 
AP Securities research analyst

Consistent CREIT 

We also like Citicore Renewables’ CREIT, which has also demonstrated consistent dividend growth over the past years. It is also very unique in the sense that its tenants are solar farms, which can’t just pack up and move to a different location unlike office or mall tenants. 

As such, it has the highest WALE (weighted average lease expiry) of 21 years and the highest occupancy rate of 100 percent compared to all the other REITs. This ensures that its income stream will not be interrupted in the foreseeable future.

The case for REIT price appreciation 

Taking a deeper dive, a spread analysis of the BSP’s benchmark rates vs. 5-year Philippine government bonds (RPGB) showed that over the past 10 years, bond yields tend to be 49 bps lower than the BSP rate.

A similar spread analysis of the 5-year RPGB yields vs. the yields of our top REIT picks – RCR and AREIT – showed a typical spread of 109 bps and 61 bps, respectively. CREIT, on the other hand, has a typical spread of 141 bps. This supports our narrative that the progression of the BSP’s rate cut cycle would translate to the lowering of yields for the entire yield curve and translate to higher prices for REITs as they become more attractive compared to bonds.

"We see [REITs] as the best entry point for investors looking to diversify away from bonds and into equities".
- Joey Cipres

At current prices, RCR and AREIT’s FY24E dividend yields have a spread of 118 bps and 65 bps against 5-year bonds, indicating that the recent decline in bond yields has not been sufficiently priced in. On the other hand, CREIT currently has a spread of 89 bps, which is narrower than its typical spread, implying that the recent drop in bond yields is more than priced in.

Favoring the upside 

However, considering that we expect a total of 125 bps worth of rate cuts from the BSP until 2025, we believe that investors still have the advantage to continue locking in relatively higher REIT yields at current prices, and this would apply to CREIT as well.

To sum it all up, we believe that a progressive transition from fixed income to REITs is a viable move for investors that want to dip their foot in the stock market without taking on significantly higher risks. 

As for the timing, we believe that now is the best time to invest in REITs as further improvements in our macroeconomic environment would only boost the investment’s attractiveness in the near future.

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Wednesday, 6 November 2024
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