It’s been a rough period for REITs in the last few months.
A common understanding is that rising interest rates will cause REITs to underperform.
There are two main arguments for this.
First, higher interest rates increase borrowing costs.
As REITs rely heavily on debt to function, a higher cost of debt will crimp their ability to pay out distributions by raising their overall expenses.
Secondly, investors have a wider breadth of investment choices that offer higher yields. In turn, a higher premium is demanded from REIT yields.
Research by DBS Group (SGX: D05) showed that almost half of the 44 Singapore REITs are trading close to 52-week lows in January.
With the situation looking dire, should investors throw in the towel and sell their REITs?
And this, too, shall pass
It’s important to remember that this period of high inflation is transient.
Reports of supply chain bottlenecks and a sudden surge in consumer demand due to the easing of pandemic-related restrictions are contributing to the sudden inflation spike.
This confluence of factors is what’s driving prices up rapidly, with Singapore also reporting that inflation for December edged up to 4% year on year.
The thing is, history has shown that high inflation usually does not persist.
In the US, since 1946, there have been a total of six episodes where inflation soared, only to come back down again to levels below 5%.
As inflation eases, the Federal Reserve will also have less incentive to continue raising rates.
Also, rates cannot be raised for a prolonged period as this monetary policy tool is a blunt one that will also cause businesses to hold back on borrowing, thus stunting the nascent economic recovery.
In a nutshell, this, too, shall eventually pass, and investors should treat it as a temporary phase that’s impacting the REITs sector.
Merits of a strong REIT
There’s also evidence that rising interest rates do not always lead to poor performance for REITs, as measured by its distribution per unit (DPU).
Take Parkway Life REIT (SGX: C2PU) as an example.
The Federal Funds rate increased from less than 1% at the start of 2016 to close to 2.5% by mid-2019, a rapid increase by any measure.
Yet, the healthcare REIT has managed to increase its core DPU during this period.
What’s more, Parkway Life REIT has also managed to keep its all-in debt cost extremely low at just 0.52% as of 31 December 2021.
The presence of quality, recession-resistant assets coupled with effective debt management are attributes of a strong REIT.
These attributes serve an income-seeking investor well by giving him or her the peace of mind that the REIT can continue to deliver during good and bad times.
The benefit of a strong sponsor
In addition, some REITs also have strong sponsors that can provide financial assistance if need be.
Mapletree Industrial Trust (SGX: ME8U) has a strong sponsor in Temasek-owned Mapletree Investments Pte Ltd, a real estate investment and development outfit with S$66.3 billion worth of assets as of 31 March 2021.
The industrial REIT also has an admirable track record of consecutive years of rising DPU since its listing in 2010.
Frasers Logistics & Commercial Trust (SGX: BUOU), or FLCT, also has a strong sponsor in property development and investment firm Frasers Property Limited (SGX: TQ5).
FLCT has posted year on year increases in DPU from its fiscal 2019 (FY2019) through to FY2021, going from S$0.07 to S$0.0768.
Tailwinds of growth
Let’s also not forget that certain REITs may be beneficiaries of long-term trends that act as tailwinds for their continued growth.
Digital Core REIT (SGX: DCRU) and Keppel DC REIT (SGX: AJBU) are two great examples.
The two data centre-focused REITs are riding on the tailwinds of digitalisation that should see sustained demand for this asset class in the foreseeable future.
What’s more, both REITs also boast reputable sponsors.
Keppel DC REIT is helmed by Keppel T&T, which is a wholly-owned subsidiary of Keppel Corporation Limited (SGX: BN4), a blue-chip offshore and marine conglomerate.
Digital Core REIT’s sponsor is Digital Realty Trust (NYSE: DLR), one of the largest owners, developers and operators of data centres worldwide that owns more than 290 data centres.
Both sponsors also have an attractive pipeline of assets that could be injected into their respective REITs for future growth.
Get Smart: Strong REITs will triumph
The evidence is clear.
Although REIT sentiment is currently weak, owning a smattering of REITs with strong attributes can still greatly benefit a dividend investor.
Choosing those with strong sponsors, an enviable distribution track record, and sustainable tailwinds is the way to go.
Rather than selling your REITs now, you should flip the script and ask yourself — could this be the perfect opportunity to buy even more?
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Disclaimer: Royston Yang owns shares of Mapletree Industrial Trust, Digital Core REIT and Keppel DC REIT.