Why Rate Hikes are not as bad for REITs as you may think

Rate hikes are bad news for REITs, at least, that is the common consensus.

Is it true?

In the article below we find out that rate hikes are not necessarily bad, and REITs always bounce back from any short term impact it may have from the rate hikes. Be it because of economic backdrop, the amount of debt within the REIT or other reasons. We will see how your income from REITs may not get affected after all.

What are Rate Hikes?

The US Federal Reserve increased their short-term interest rate for the first time in a decade in 2015, followed by another one in 2016. They are poised to make two more rate hikes in 2017. These rate hikes impact the lending rate or the cost of borrowing. Companies that rely heavily on borrowed funds may face higher costs to finance their debts.

Why should it impact REITs?

Since REITs pay out a major portion of their profits, they usually rely on debt financing for the expansion of projects. Higher costs of financing may make the REITs less profitable.

 

Does this mean we should sell our REITs? Let’s find out

 

REITs always bounce back

 

Since the global crisis in 2008, interest rates has gone down consistently, with only a few increases.

S&P Asia Pacific REIT USD Total Returns vs 10 Year US Treasury Yield

2011 onwards we see an inverse relationship between the US 10 year Treasury yield and APAC REITs Total returns. While rates remained low till 2013, the total returns number grew considerably.

In 2013, since US Federal Reserve first started considering raising the short-term interest rate, we see a rise in the 10 year Treasury yield. The APAC REITs were impacted, losing almost 18% of its value in just a month. However, it bounced back within six months and went on to gain almost 50% from its lowest point over the next couple of years.

In 2016, after the actual short-term rate hike was announced by the US Federal Reserve, we see another drop, this time around 14%. However, within four months the trend has reversed, and we see positive growth, roughly 9% in six months.

It is evident that rate hikes do impact REITs, but the impact is short term as REITs always bounce back very quickly.

 

Your Income from REITs is not affected

 

The 2013 rate hike may have caused a small dip in DPU in 2014 for Australia. However, Singapore and Hong Kong both gained. As for Australia, the DPU rose again in 2015 and 2016 thus displaying no long-term impact of the rate hike. All major REIT markets were able to grow their DPU despite rate hikes proving income from REITs were not impacted.

Dividend per Unit for Major APAC REIT Markets

So how do the REITs shrug-off the impact of rate hikes?

 

Rate hikes are not bad

 

Interest rates are usually used as incentives for economies to grow, lowering them considered an invitation for investors to lend more and invest thus expanding the economy. When the opposite happens, it usually means the economy is doing well. And when the economy does well, it all bodes well for the REITs. Malls see more shoppers; business parks see more tenants, hotels see more guests, the list goes on. The REITs can increase their rents thus easily offset the rising cost of debt.

 

Not all REITs are heavily geared

 

Singapore REITs are bound by the law to have a gearing ratio (debt to assets) below 45%. The median stands at 34%, meaning some REITs are borrowed well below their allowable limits making them less susceptible to rate hikes. In Australia, the gearing levels for the REITs are close to 30% in 2016. Therefore, while some REITs may get affected, a lot of them will not be impacted much.

 

Short Term vs. Long Term Debt

 

Gradual rate hikes harm short-term debt holders, as they have to adjust their debt consistently and as rates rise so does their costs. For long-term debt holders, such rate hikes pose no immediate threat. For Singapore REITs, the short-term debt is less than 2%, thus making them better equipped to manage impacts of a rate hike.

 

We are certainly not saying REITs are impact-free from rate hikes; we can see evidence that they are well prepared to offset the downsides thus resulting in overall growth of total returns.

 

Want to invest in REITs but don’t have the time to do the hard work? Let us manage it for you. Phillip Singapore Real Estate Income Fund allows you to invest in an actively managed S-REIT fund where we worry about things like interest rates, and you get quarterly dividends per year. More info here.

Want to invest in a basket of top 30 dividend paying REITs in the Asia Pacific? Try our very own Phillip SGX APAC Dividend Leaders REIT ETF. Learn more here.

 

Sources: Phillip Capital Management, Bloomberg, A-REIT Survey 2016 by BDO 

 

Questions? Comments?

Drop us an e-mail: pcm@phillip.com.sg

 

 

 

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