If you are a REIT investor, you may feel like you are stuck in a long, dark tunnel.
The sector has been pummelled hard by the sharp rise in interest rates along with surging inflation.
This combination of headwinds has caused many REITs to report higher expenses which have, in turn, crimped their ability to increase their distribution per unit (DPU).
To add insult to injury, remote work has persisted even as the pandemic wanes, causing certain property sectors to experience flagging occupancy rates.
With many REITs trading at their 52-week lows, is there any hope on the horizon for a rebound?
Interest rate woes
The speed at which interest rates have risen has resulted in sharply higher finance costs for many REITs.
Here are some examples.
For Frasers Logistics & Commercial Trust (SGX: BUOU), revenue for the first half of fiscal 2024 (1H FY2024) inched up just 3.9% year on year to S$216 million.
The REIT’s finance costs, however, jumped 34.5% year on year to S$29.2 million.
A similar scenario played out for CDL Hospitality Trusts (SGX: J85).
The hospitality trust saw its revenue for 2023 rise 12.3% year on year to S$257.6 million but finance costs soared 40.4% year on year to S$63.3 million.
REITs are also seeing their overall cost of debt creeping up.
OUE REIT (SGX: TS0U) saw its weighted average cost of debt rise from 4.3% at the end of 2023 to 4.5% for the first quarter of 2024.
Meanwhile, Mapletree Pan Asia Commercial Trust’s (SGX: N2IU) cost of debt increased from 2.68% for fiscal 2023 (ending 31 March 2023) to 3.35% for fiscal 2024.
A sliver of light at the end of the tunnel
These increases have, of course, weighed on REITs as they cut into their distributable income.
But there could be some light appearing at the end of the tunnel.
The recent US jobs report showed 200,000 jobs gained, pushing the country’s unemployment rate to its highest level since November 2021.
The employment report is not the only data point that could sway policymakers’ interest rate decisions.
The US inflation rate also fell to 3.3% for May, below the 3.4% which economists expected.
The Bureau of Labor Statistics also showed zero month-on-month inflation with core inflation inching up by just 0.2 percent.
These data points may convince the US Federal Reserve to begin cutting interest rates as soon as September, according to analysts.
If interest rates do fall, they will offer REITs some relief as they refinance debt.
Remember too that interest rates cannot stay high indefinitely as consumer sentiment and business expansion will be negatively impacted by high rates.
Inflation is not the only item on the central bank’s agenda and policymakers need to ensure that the economy is also chugging along fine.
It should be a matter of time before interest rates need to come down to provide some respite for consumers and businesses.
Stick with quality
During tough times, it is a good idea to stick with quality.
REITs are portfolios of real estate that are professionally managed.
Their purpose is to earn rental income and pay out a portion of this income to unitholders.
Hence, income investors should look for REITs with well-located properties that enjoy high demand.
A strong sponsor is another advantage a REIT can have.
Overall borrowing costs will be lower if the REIT is backed by a reputable sponsor.
The sponsor will also have a promising pipeline of assets that can be injected into the REIT in due course.
One example of a REIT with a strong sponsor that has managed its finance costs well is Mapletree Industrial Trust (SGX: ME8U).
The industrial REIT saw its finance expenses dip by 0.3% year on year for its latest quarter and is also supported by its sponsor Mapletree Investments Pte Ltd.
First REIT’s (SGX: AW9U) finance expenses for the second half of 2023 were well-controlled, rising by just 4% year on year to S$11.5 million.
The healthcare REIT also has OUE Healthcare Limited (SGX: 5WA) as its sponsor.
Get Smart: The best REITs will prevail
As the saying goes – tough times don’t last, but tough people do.
REITs are going through a tough phase because of persistent interest rate headwinds.
So, hang in there.
Keep your faith in well-managed REITs that have quality portfolios.
The best time to accumulate more of such REITs is when sentiment is poor as the pessimism will push up distribution yields to attractive levels.
When interest rates eventually come down, the REIT sector will then have its turn to bask in the sun.
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Disclosure: Royston Yang owns shares of Mapletree Industrial Trust and Frasers Logistics & Commercial Trust.
