Singapore REITs have taken a beating in 2023.
The iEdge S-REIT index, the benchmark for Singapore REITs, is down 14% from its peak as of last Friday.
The main culprit? Rising interest rates.
Some investors think that higher interest rates are bad for S-REITs. They believe that when interest rates go up, REIT prices will go down.
But that’s not always true — the reality is more nuanced.
Let me explain.
How fast, not just how much
Interest rates have risen before. And S-REITs have done well in those times.
Between 2015 to 2018, interest rates went up from 0% to 2% in 36 months.
But some S-REITs, such as CapitaLand Integrated Commercial Trust (SGX: C38U), increased their distribution per unit and unit price.
CICT’s dividend per unit (DPU) went up from S$0.1113 in 2016 to S$0.115 in 2018. The REITs unit price also went up from S$1.91 in 2016 to S$2.27 in 2018.
So, rising interest rates don’t always hurt S-REITs.
But if that’s the case, what happened in 2023?
Abnormal times
The problem was not just rising interest rates. It was also the speed of the increase.
The slide below shows the difference.
From the above, you can see the gradual rise in interest rates from 2015 to 2018 (green box). And you can see the steep rise in 2022 (red box).
These numbers tell the story.
In 2022, interest rates jumped from zero to 4.5% in nine months, a huge shock for the stock market. It’s also an abnormal rate of change — when you compare the 2022 increase with previous hikes.
Interest rates also rose in 2023.
However, the increase was only one percentage point. Hence, the pace of increases was much slower in 2023 compared to 2022.
What does this mean for S-REITs?
In my mind, the rate of change matters more than the magnitude of change.
The REITs’ Achilles heel
All REITs use debt to finance property purchases.
Most of the time, they only pay the interest expense and retain the debt on their balance sheet.
Hence, when interest rates rise, REITs have to pay more.
In addition, if there are any loans which become due during the year, they have to be refinanced.
Given how fast interest rates have risen in 2022, it wouldn’t be a surprise to see REITs refinance these loans at higher interest rates in 2023.
Thus, interest expense rises, eating into the REITs’ distributable income.
Now, it’s not to say that Singapore REITs are doomed.
There are things the REIT manager can do to limit the impact of interest rates.
If we go back to the example of CICT, its REIT manager has spread out its debt refinancing by an average of about four years. What’s more, in any year, no more than 16% of its overall debt comes due, giving the REIT time to adjust to the changing interest rate environment.
Given time, CICT will likely raise rental rates to cover the higher interest expenses.
Get Smart: Stayin’ Alive
Interest rates have been a huge headwind for REITs.
We are already seeing the effects in the individual Singapore REITs. But it doesn’t mean that the entire sector is doomed to mediocre returns.
There are ways to limit the impact and in some cases, even grow DPU.
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Disclosure: Chin Hui Leong owns shares of CICT.
