For loyal unitholders of REITs, things are not looking pretty this year.
Share prices have taken a beating amid surging interest and inflation rates as the world transitions to the post-pandemic era.
The sell-off is not completely unjustified as higher-than-expected interest rates will raise borrowing costs for REITs, eating into the amount of distributable income they can pay out to unitholders.
In this new economic environment, there is an even greater need for investors to seek out REITs with strong balance sheets and healthy capital structures.
For instance, a REIT with a higher proportion of fixed-rate debt will be better insulated from paying higher financing costs.
An example is CapitaLand Integrated Commercial Trust (SGX: C38U), or CICT.
The REIT recently released its latest business update for the third quarter of 2022 (3Q2022).
Despite higher interest rates, the retail cum commercial REIT has turned in an even stronger performance in this quarter than in its fiscal 2022’s first half (1H2022).
This resilient performance can be attributed to the REIT’s adept capital management as well as its continuous efforts to optimise its existing portfolio.
Here are five highlights from CICT’s latest business update.
1. Accelerating growth in financials
CICT reported a steady financial performance for 3Q2022.
The REIT reported gross revenue of S$374.1 million for the quarter, 13.7% higher year on year.
NPI grew by 12.7% year on year to reach S$273.3 million.
This brought the total NPI for the first nine months of 2022 (9M2022) to S$775 million, which translates into a 8.4% year on year increase.
The increase was consistent across all three of the REIT’s asset sub-classes.
Retail assets, office assets and integrated development all saw their gross revenue and NPI rising.
Growth was the fastest for retail assets.
During the quarter, revenue soared 29.6% year on year to S$126.1 million while NPI also surged 27.8% year on year to S$95.4 million.
2. Return of brick and mortar
Brick and mortar stores are starting to see the light at the end of the tunnel as safe distancing measures have gradually eased throughout the year.
Coupled with the re-opening of borders, this has led to retail sales recovering to their pre-pandemic levels.
Both shopper traffic and tenant sales saw major improvements year on year for 9M2022, with the former rising by 21.9% and the latter increasing by 21.3%.
Year-to-date (YTD) tenant sales per square foot have also surpassed that of 2019.
This should help the retail assets command a positive rental reversion going forward since tenants can now afford to pay higher rental fees.
These positive rental reversions will translate into higher rental income, resulting in a higher distribution per unit (DPU), which bodes well for long-term unitholders.
To capitalise on the recovery in shopper traffic, the REIT has been experimenting with new retail concepts for a better shopping experience.
These new initiatives are supported by surveys to identify current shopper trends and motivations.
Hotel occupancy rates have increased from 56.5% since the start of the year to 78.2% in August2022.
The increase in the number of international visitors should help to further boost retail sales.
3. Improvement in operating metrics
For retail assets, rent reversion was a positive 0.6% for incoming average rents versus outgoing rents for 9M2022.
In comparison, retail asset rent reversion was slightly negative at 0.5% in 1H2022.
Meanwhile, Singapore office rental rates saw a positive rent reversion of 7.9% for 9M2022, slightly lower than the 8.5% chalked up in 1H2022.
Total occupancy rates increased from 93.8% at the end of the previous quarter to 95.1% in 3Q2022.
Overall, CICT’s weighted average lease expiry (WALE) stood at a healthy 3.8 years as of 30 September 2022.
4. Asset enhancement initiatives
CICT continues to embark on asset enhancement initiatives (AEI) to optimise its portfolio and drive rental income growth.
An AEI costing S$62 million, CQ @ Clarke Quay, has officially commenced.
The various upgrading and improvement works are to be done in phases, and are estimated to be completed by 3Q2023.
Elsewhere, CICT is planning to open up flexible working spaces and more amenities at Six Battery Road.
The 42-storey Grade A office building has achieved a committed occupancy of 91.2% as of 30 Sep 2022.
Lastly, WeWork’s flagship and largest outlet at 21 Collyer Quay was officially opened.
These initiatives should, over time, reward patient shareholders with higher distributions.
5. Buffering against higher interest rates
To curb rising inflation, the US Federal Reserve has hiked interest rates by 0.75 percentage points over three consecutive sessions thus far.
CICT’s trailing 12-month (TTM) DPU spanning across 2H2021 and 1H2022 amounted to a total of S$0.1044.
CICT has communicated that a 1% increase in interest rates will lower its DPU by an estimated S$0.003.
The 2.25% increase in interest rates (i.e. 0.75% x 3) thus far has resulted in DPU declining by S$0.0063, representing a 5.7% drop for the REIT’s TTM DPU.
With another possible rate hike still to come, investors need to be mentally prepared that DPU could decline further.
Against such a pessimistic backdrop, dividend investors should be wary of REITs with high leverage ratios.
This is because REITs will end up forking out higher finance costs.
For CICT, aggregate lending increased slightly from 40.6% at the end of 30 June 2022 to 41.2% at the end of 30 September 2022.
Interest coverage ratio decreased from 4.1x in the previous quarter to 3.9x over the same period.
Meanwhile, the percentage of borrowings based on fixed interest rates remained high at 80%.
A high proportion of fixed-rate debt should provide some buffer against the adverse effects of the rising interest rate environment.
CICT’s average cost of debt increased only slightly from 2.4% in 1H2022 to 2.5% as at 3Q2022.
Moreover, CICT’s aggregate leverage is still some distance away from the maximum allowable 50% limit set by regulatory bodies.
Investors need to monitor CICT’s debt metrics moving forward to see how the REIT copes with the rise in interest rates.
But with CapitaLand Investment Limited (SGX: 9CI) as its sponsor, the REIT has the financial support to help it tide over this difficult period.
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Disclosure: Ryan Yap does not own any of the shares mentioned.