The REIT sector is not out of the woods yet.
Inflation in the US has remained elevated, rising by 3.5% year on year in March.
Because of this headline number, investors are now less confident that the US Federal Reserve will cut interest rates.
With the REIT earnings season fast approaching, here are five aspects that investors need to watch out for.
Finance costs
With interest rates poised to remain higher for longer, income investors should keep a close watch on REITs’ interest costs.
In particular, they should monitor the interest expenses as a proportion of the REIT’s rental income to get a sense of how badly the high-interest rates are impacting the REIT.
As an example, Elite Commercial REIT (SGX: MXNU) recently reported its 2023 earnings.
Finance costs came in at GBP 12.4 million for 2023, taking up nearly 33% of the commercial REIT’s revenue of GBP 37.6 million.
This proportion was a sharp jump from the 20% in the prior year and could be a cause for concern.
Contrast this with Mapletree Industrial Trust (SGX: ME8U), or MIT.
For the first nine months of fiscal 2024 (9M FY2024), MIT’s finance costs made up just 15.2% of its gross revenue.
This was a small increase from 13.6% in the prior period (9M FY2023).
The key is to watch the rise in finance expenses year on year and to compute the proportion of it to the REIT’s gross revenue.
Distribution per unit (DPU)
The next aspect is one of the most looked at attributes of a REIT – its distribution per unit (DPU).
Understandably, the current higher rates have crimped the distributable income for many REITs as expenses have shot up.
Hence, it may be tough to find REITs that are reporting higher year-on-year DPU.
What investors can look out for are how REITs can mitigate the rise in interest rates and whether the DPU decline is slowing down.
Again, we go back to the example of MIT.
For its 1Q FY2024, DPU fell by 2.9% year on year to S$0.0339.
The DPU decline fell to 1.2% in the next quarter (2Q FY2024) and shrank even more by 3Q FY2024 to just 0.9% year on year.
Over three quarters, investors should note that the DPU decline is gentler and that the industrial REIT may be on the path to seeing an increase in its year-on-year DPU.
Proportion of fixed-rate debt
Still on the higher interest rates point, REITs should peg more of their debt to fixed rates to help mitigate the increase in finance costs.
MIT has close to 80% of its loans on fixed rates so this should help mitigate a sharp increase in finance expenses.
Elite Commercial REIT has around two-thirds of its debt on fixed rates for 2023, a slight increase from 62% as of 30 September 2023.
For Far East Hospitality Trust (SGX: Q5T), however, just 42.6% of its debt is pegged to fixed rates.
REIT investors should watch this percentage to determine if finance costs could shoot up further for a REIT.
Acquisitions and AEIs
An effective method to offset the adverse impact of higher costs is for a REIT to engage in acquisitions and asset enhancement initiatives (AEIs).
Yield-accretive acquisitions help to boost a REIT’s asset base while also bumping up DPU in the process.
Mapletree Logistics Trust (SGX: M44U) completed a total of S$900 million in acquisitions of modern, grade-A assets by acquiring nine properties in Japan, South Korea, Australia, and India.
Keppel REIT (SGX: K71U) recently acquired a 50% stake in 255 George Street in Australia for A$363.8 million which will add 1.4% to its DPU.
AEIs are a great method for a REIT to grow its rental income organically and to improve the attractiveness and rental demand for its properties.
CapitaLand Ascendas REIT (SGX: A17U) reported five ongoing projects in Singapore worth S$551 million to improve its portfolio’s quality.
OUE REIT (SGX: TS0U) just completed the AEI for Crowne Plaza Changi Airport and now has a full inventory of 575 rooms since January this year.
Sponsor’s pipeline
Finally, a fifth aspect to look for is the pipeline of assets that a REIT’s sponsor has.
With the acquisition environment becoming tougher because of higher interest rates, having a strong pipeline is key to a REIT’s future growth.
Keppel DC REIT (SGX: AJBU) disclosed that it has more than S$2 billion worth of potential data centre assets for acquisition from its sponsor Keppel Ltd (SGX: BN4).
Last month, Frasers Logistics & Commercial Trust (SGX: BUOU) acquired a near-90% interest in four logistics properties owned by its sponsor Frasers Property Limited (SGX: TQ5).
These are some examples of REITs that can rely on their sponsor for asset acquisitions that can help them grow both their asset base and DPU over time.
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Disclosure: Royston Yang owns shares of Keppel DC REIT, Mapletree Industrial Trust and Frasers Logistics & Commercial Trust.
