Time flies and earnings season is almost upon us again.
The usual practice is for REITs to report their results first followed by the trio of local banks.
There is a change in the air, though.
Investors will be closely scrutinising this quarter’s REIT earnings amid an environment of high inflation and rising interest rates.
The purpose is to assess if REITs may be adversely affected by these new economic developments.
And if you are an income-seeking investor, you will be concerned about REITs’ ability to continue doling out distributions as costs increase.
REITs are well-known for being reliable dividend payers, and investors are naturally concerned if this dependability may be disrupted.
Here are three red flags you should watch out for when REITs report their results in the coming weeks.
REITs are an asset class that relies heavily on borrowings to fund both their operations and acquisitions.
Hence, it’s no surprise that interest rates have a significant bearing on REITs’ financial costs and, in turn, their distributable income.
Investors need to look at each REIT’s debt metrics to assess how well it can cope with rising interest rates.
First off, you need to look at the REIT’s cost of debt.
A lower cost of debt ensures that the REIT has a bigger buffer in a rising interest rate environment.
Take Mapletree Logistics Trust (SGX: M44U), or MLT.
The logistics REIT sported a weighted average annualised cost of debt of 2.3% as of 30 June 2022.
Parkway Life REIT (SGX: C2PU) boasts an even lower cost of borrowing with its all-in debt cost of just 0.61%.
A REIT’s cost of debt has a lot to do with the foreign currency it can borrow in, and also whether it has a strong sponsor to assure banks that the REIT has a lower risk profile.
Contrast this to China-based Sasseur REIT (SGX: CRPU) which has a weighted average cost of debt of 4.5%.
Another important metric to look at is the proportion of fixed-rate debt within the REIT’s array of loans.
The higher this component, the more buffer it has when it comes to rising finance costs.
For MLT, 80% of its total debt is hedged or drawn in fixed rates.
Suburban retail REIT Frasers Centrepoint Trust (SGX: J69U), or FCT, has 69% of its total loans on fixed rates, while retail and commercial REIT CapitaLand Integrated Commercial Trust (SGX: C38U), or CICT, has 81% of its borrowings tied to fixed interest rates.
Apart from debt metrics, REITs should also disclose the sensitivity of their distribution per unit (DPU) to the rise in base interest rates.
By doing so, investors can assess the approximate impact on the REIT’s distributions each time rates go up.
For CICT, every one percentage point rise in interest rates will lower DPU by S$0.0028.
The decline represents 2.7% of CICT’s trailing 12-month DPU of S$0.1044.
MLT estimates that a 0.25 percentage point increase in base interest rates will result in a S$0.0001 decline in DPU per quarter.
The decline is 0.4% of its fiscal 2023’s first quarter DPU of S$0.02268.
Frasers Logistics & Commercial Trust (SGX: BUOU) will witness a S$0.0005 fall in DPU for each 0.5 percentage point increase in interest rates for its variable rate loans.
This drop works out to be around 0.6% of the REIT’s annualised fiscal 2022’s first-half DPU of S$0.0385.
From the above examples, it’s easy to quantify the effects of rising interest rates on these REITs’ DPUs.
Although the recent surge in interest rates will result in across-the-board falls in DPU, REITs have various methods to mitigate this decline.
The impact of inflation
The third aspect to watch for is the effect of inflation on the operating expenses of the REIT.
Common property operating expenses include utilities, property management fees, marketing expenses, maintenance costs, and staff salaries.
There has already been news of a sharp jump in utility costs as electricity and gas expenses rose 23.9% year on year in August.
Labour costs are also expected to rise as employees demand higher salaries to cope with food and transport inflation.
These expenses will add up to reduce the distributable income for the REIT and is an area that investors should monitor in the coming quarters.
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Disclaimer: Royston Yang owns shares of Frasers Logistics & Commercial Trust.