It would be an understatement to say that the first half of this year was turbulent.
Stock markets were roiled not just by high inflation and a surge in interest rates, but have also plunged as the spectre of a recession loomed.
Amid this uncertain environment, we decided it was time for a much-needed review of various sectors such as banks, consumer goods, and semiconductors.
In this round, we turn to a popular asset class for income-seeking investors – REITs.
REITs are well-known for delivering a steady stream of dividends as well as steady capital appreciation as the value of their properties rises.
With what’s going on in the world currently, can they continue to do well?
Let’s take a look at the various factors at play that will impact the REIT sector in the coming quarters.
Increased borrowing costs
The most obvious effect of higher interest rates is that financing costs for REITs will surge.
REITs are leveraged instruments that rely on debt to finance both their operating expenses and fund acquisitions.
With higher rates, distributable income may come under pressure as finance costs rise across the board.
Luckily, many REITs had prepared for such scenarios and have hedged most of their debt to fixed rates to mitigate the impact.
Mapletree Logistics Trust (SGX: M44U), or MLT, announced in its latest fiscal 2023’s first quarter (1Q2023) earnings that 80% of its total debt is hedged or drawn based on fixed rates.
In addition, just around 9% of its total debt is due this fiscal year, and its debt maturity remains well-staggered.
As for Parkway Life REIT (SGX: C2PU), its all-in cost of debt was a very low 0.56% as of 31 March 2022, providing the REIT with sufficient buffer in case of a sharp rate rise.
Moreover, the healthcare REIT had also executed new hedges for its Japanese Yen-denominated debt that ensured around 81% of its interest rate exposure is hedged.
Tenants under strain
Apart from interest rates, REITs also have to worry about high inflation and an economic slowdown that may morph into stagflation.
There are two aspects to this problem.
First off, high inflation will raise REITs’ operating costs in areas such as staff salaries and property operating expenses.
In turn, the REIT will report lower levels of distributable income as net property income is negatively impacted.
The second aspect is the strain on tenants as they grapple with higher costs and lower demand.
The increased financial stress may cause weaker tenants to give up their tenancy while others may have problems coughing up the cash to service their rentals.
These problems will translate to a lower occupancy rate for REITs and lead to lower rental income.
Operating costs are tough to mitigate, but REITs can ensure that occupancy levels remain high with a stable of strong and reputable tenants.
Mapletree Industrial Trust’s (SGX: ME8U) average portfolio occupancy stands at 94% as of 31 March 2022, and it also has a large and diversified tenant base with the largest tenant contributing just 6.1% to gross rental income.
Tenants include reputable names such as HP Inc (NYSE: HPQ), AT&T (NYSE: T) and the Bank of America Corp (NYSE: BAC).
Opportunities to acquire
With interest rates on the rise, REITs will find it tougher to conduct yield-accretive acquisitions.
The pool of assets available will also shrink as other REITs or property companies seek out higher-yielding real estate.
Hence, REITs with a strong sponsor that has a ready pipeline of assets to be injected in are at an advantage.
The presence of a sponsor’s assets will minimise the search costs for the REIT while it can also rely on the sponsor to help stabilise the asset before injecting it into the REIT.
Keppel DC REIT (SGX: AJBU) has more than S$2 billion worth of potential data centres for acquisition from its sponsor, Keppel Corporation Limited (SGX: BN4).
Similarly, CapitaLand China Trust (SGX: AU8U) announced that the acquisition pipeline from its sponsor, CapitaLand Investment Limited (SGX: 9CI), comprises a total of 49 properties consisting of retail, commercial, and new economy assets.
Another REIT that has a strong sponsor with a pipeline of injectable assets is Frasers Logistics & Commercial Trust (SGX: BUOU).
Its sponsor, Frasers Property Limited (SGX: TQ5), has total assets of around S$40.3 billion as of 30 September 2021 spread out across multiple property sub-classes.
Get Smart: Stick with well-managed REITs
The verdict is out – REITs still have the opportunity to grow, albeit at reduced rates.
The key is to stick with the well-managed ones that have strong sponsors and which have proven their ability to grow their distributions through good times and bad.
If you follow this advice, you won’t go far wrong even if the economy dives in the coming months.
Not sure which REIT to put your money in? Use our 7-step REIT checklist to find one that fits into your retirement plan. Checklist is inside our latest FREE report “Singapore REITs Retirement Plan”. Click here to download it now.
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Disclaimer: Royston Yang owns shares of Mapletree Industrial Trust, Frasers Logistics & Commercial Trust and Keppel DC REIT.
