Income investors have relied on the REIT sector for a steady flow of income for many years.
The beauty of owning a REIT is that it is mandated to pay out at least 90% of its profits as distributions to enjoy tax benefits.
This requirement makes REITs suitable as income instruments that can supply income investors with a reliable flow of passive income.
However, since 2022, REITs have been under pressure as the US Federal Reserve (“Fed”) hiked interest rates sharply to combat inflation.
Many REITs have seen their distributable income come under pressure because of higher operating expenses and finance costs.
Can investors still make a case for investing in Singapore REITs amid this high-interest-rate environment?
Interest rates may stay “higher for longer”
For investors who are watching interest rate movements, last year saw the Fed cut interest rates by a full percentage point during three sessions.
The federal funds rate now stands between 4.25% to 4.5%.
However, looking ahead, the US central bank has pencilled in just two rate cuts this year, down from the four that it had forecasted back in September 2024.
“Higher for longer” is now the mantra for 2025 as the Fed has revised its inflation expectations upwards for 2025.
The latest economic data in the US showed that the manufacturing sector expanded in December, but the price index jumped to a two-year high of 64.4, up from the previous 58.2.
Job openings also rose more than expected in November, leading investors to bet with almost certainty that the central bank will keep rates steady this month.
With Donald Trump taking office as the President on 20 January, there are worries that his tariff policies may reignite inflation.
Should inflation start to pick up once more, the Fed may alter its dot plot and pencil in even fewer or no cuts for 2025.
DPU continues to head upwards
Even as income investors fret over the direction of interest rates, there’s a silver lining in the REIT sector.
Several REITs have bucked the trend by announcing increases in their distribution per unit (DPU) despite the headwinds.
For the third quarter of 2024 (3Q 2024), Keppel DC REIT (SGX: AJBU) saw its DPU rise by 0.4% year on year to S$0.02501 on the back of an 8.9% year-on-year increase in gross revenue.
Over at Parkway Life REIT (SGX: C2PU), the healthcare REIT saw its DPU for the first nine months of 2024 inch up 2.8% year on year to S$0.113.
Mapletree Industrial Trust (SGX: ME8U) also pulled off a small year-on-year DPU increase.
The industrial REIT’s DPU edged up 1.3% year on year to S$0.068 for the first half of fiscal 2025.
An important criteria
It’s impressive to read about REITs that can still increase their DPU despite the macroeconomic challenges.
There is one common theme that ties these three REITs, and that is the presence of a strong sponsor.
A good sponsor helps to lower the REIT’s borrowing costs while also providing it with a steady pipeline of properties to acquire.
Parkway Life REIT has a reputable sponsor in IHH Healthcare Berhad (SGX: Q0F), Mapletree Industrial Trust’s sponsor is real estate giant Mapletree Investments Pte Ltd, and Keppel DC REIT’s sponsor is blue-chip asset manager Keppel Ltd (SGX: BN4).
Having a good sponsor behind a REIT is already half the battle won.
REITs are not sitting ducks
Remember that REITs are also not sitting ducks when it comes to managing their portfolios.
Experienced managers will know how to navigate a high-interest-rate environment and help the REIT to continue growing.
There are several initiatives that REITs can undertake to mitigate the scourge of higher interest rates.
The first will be acquisitions to help to boost the REIT’s asset base and lift its DPU.
Keppel DC REIT recently pulled this off when it announced a S$1.4 billion acquisition that will increase its DPU.
REITs can also carry out asset enhancement initiatives or AEIs that help to improve and spruce up the properties within their portfolios.
Additional gross floor area or net lettable area (NLA) may be created through such AEIs, thus contributing to organic rental growth.
A recent example is Frasers Centrepoint Trust (SGX: J69U) which recently completed its AEI of Tampines 1 Mall.
More than 9,000 square feet of NLA was created and deployed to prime retail floors, thus enhancing the mall’s overall rental income stream.
Get Smart: Focus on the quality REITs
It may come as bad news for income investors, but interest rates look poised to remain high for the foreseeable future.
Even if interest rates do eventually decline, they may not go back to their near-zero days.
It’s prudent for you to select REITs with solid attributes as discussed above that can not only help to mitigate these risks, but also steadily grow their DPU over time.
The idea is to focus on quality REITs and include these within your portfolio to ensure you continue to enjoy a steady stream of dividend income.
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Disclosure: Royston Yang owns shares of Keppel DC REIT and Mapletree Industrial Trust.
