Do rising interest rates truly affect Singapore REITs?
Interest rates have fallen to one of the lowest levels in years.
In fact, it’s never been so low over the last 37 years when Paul Volcker pulled interest rates close to 15%.
And now rates are rising aggressively.
I’ve put together a definitive guide to understand how rising rates affect Singapore REITs. I’m going to cover a few key points here:
- Why is rising rates bad for Singapore REITs?
- How does rising rates affect Singapore REITs?
- How does Singapore REITs perform during rising rates?
- How to invest in Singapore REITs?
- Not all Singapore REITs are created equal
- Final thoughts: Rising rates on Singapore REITs
Let’s quickly dive in.
Warren Buffett says before: “Interest rates are like gravity and as it goes up, it pulls asset prices lower.” Many people have speculated that interest rates will eventually go up.
And the Federal Reserve has already planned to raise rates a number of times.
The problem is, you don’t know how much it will go.
That will affect prices.
Why rising rates bad for Singapore REITs?
First, it’s easy to think why rising rates matter for Singapore REITs. You see, Singapore REITs borrow a lot of debt to grow — interest rates go up, REITs’ borrowing costs go up.
What’s more crucial here is this: Singapore REITs are frequently treated as a bond alternative. I’ll explain.
When rates go up, the interest on bonds, the interest on fixed deposits, go up.
These “fixed income” assets compete with Singapore REITs for your money. Remember — REITs are treated like a bond. The opportunity cost of owning Singapore REITs gets higher. There’s lower demand for Singapore REITs, and forces REIT’s yield to go up.
Here’s another explanation (skip this part if you don’t want all that academic stuff).
A bond is guaranteed to pay coupons every half year.
Similarly, a REIT collects fixed rent every month. Sometimes, these rents can be adjusted upwards. Sometimes, these rents are adjusted downward.
But overall, it’s the fixed, long-term leases that many fund managers treat REITs like a bond.
And REITs with long leases give very good income visibility. Since the rent don’t get adjusted much. So in a rising rate, the rent stays the same and doesn’t adjust higher with inflation. So it’s crucial to see which REITs can adjust their rent with inflation.
They have less flexibility to adjust the cash flow they get form tenants. This makes them more sensitive to interest rates going up.
That’s why people to compare the difference between dividend yield and the government bond yield. On average, the difference is 3.8%.
But if government bond yield goes up, dividend yield also must go up.
Source: Goldman Sachs Research
Because Singapore REITs value comes from dividend income rather than growth, the yield must go up (and share price fall) to attract back investors.
This creates a spiral effect, which leads me to the next point…
Singapore REITs pay out at least 90% of their distribution as dividend income. So that management avoids paying corporate taxes. The result?
Singapore REITs don’t keep much cash.
Now, when Singapore REITs grow, they need cash. So they not only borrow debt. But they also raise capital from the stock market — this is called rights issue.
For example, in my previous article here, Singapore REITs consistently raise rights to fund their acquisitions.
Over the years, you see Singapore REITs issuing more and more rights.
For example, over the past 10 years, Ascendas REIT has doubled their total shares from 2 billion to 4 billion shares.
As the mother of Industrial properties, this is a feature of Singapore REITs.
Source: Ascendas REIT Annual Reports Filings, Dividend Titan
If you think about this: in rising rates environment, REITs suffer from lower share price, lower DPU. Thus, REITs have to raise more “expensive” capital this way.
This means it has to issue more shares to raise the same amount of capital. It becomes expensive for investors. And further creates a spiral effect.
That’s why Singapore REITs often borrowing debt instead.
Unlike US REITs where their average debt maturity can be as long as 30 years, Singapore REITs tend to borrow very short term debt.
Keppel, CapitaLand and Mapletree families have an average 3 years debt maturity profile, interest cost of 2%/year and fixed rate of more than 70%+ (see below).
On average, when their debt mature, in a rising rate environment, these REITs often have to refinance at a much higher interest rate.
Credit: Goldman Sachs Research
In fact, some of the more risky REITs have a high debt cost, and also have a very short tenor like ESR-LOGOS-REIT (see red highlight below).
This type of REITs can suffer badly in rising rates.
How does rising rates affect Singapore REITs?
Higher rates could be bad for Singapore REITs. According to analysts, a rise in borrowing costs could result in a drop of this amount of DPU.
Some of the big Singapore REITs will experience an average drop of 3.6% in DPU if rates go up by 0.4%.
That’s not a lot but still some impact.
Source: ESR-LOGOS-REIT Presentation Slides
Ascendas REIT calculated their own scenario analysis:
- A 0.2% increase in rates, their DPU will drop by 0.4%
- A 1% increase in rates, DPU will only drop by 2%. This is based on last year’s distribution.
Note: Ascendas REIT has been actively growing its portfolio and DPU over the past few years.
Source: Ascendas REIT FY2021 Presentation Slides
As long interest rates are manageable, a rise in rates won’t impact the DPU significantly.
For example, Ascendas REIT’s scenario table shows that it’s rising rate impact on DPU is minimal.
How does Singapore REITs perform during rising rates?
I’ve explained why rising rates are bad for REITs.
And the Fed is getting all ready to pump up the rates.
But the thing is, I’m not selling my Singapore REITs today.
You see, in general, REITs actually perform well in higher rates environment.
And the truth is, REITs still beat the market.
First, let’s take a step back, look at things globally.
An S&P Dow Jones Research shows over six different periods (see below). And REITs have performed well in most of them. In fact, REITs have outperformed the stock market index during periods when rates go up.
Only two of the six periods below showed a slight underperformance.
Credit: S&P Dow Jones Indices
What’s interesting to note here: between 1994 to 2021, REITs have shown positive returns in 85% of rising interest rates period.
And it has also outperformed the S&P 500 over 50% of rising interest rates period.
Rising interest rates seem to do well for REITs.
How about Singapore REITs?
According to Lion Global Investors research, it seems like there’s little correlation between Singapore REITs and interest rates movement.
After the global financial crisis in 2008, Singapore REITs have continued to edge higher year after year.
At the same time, interest rates shown below have moved up and down over the same time period.
Singapore REITs recorded a positive total return in the periods when rates go up.
Credit: Lion Global Investors
If we zoom into detail, the times when rates go up in early 2004 and 2015, REITs have either performed strongly or have been pretty good.
It’s only times when there’s a rate cut then REITs go down.
The funny thing, is REITs generally recover over time.
What’s more, over time, including dividends, REITs have beat the general market index over the last 10 years, growing at around 13% CAGR.
That’s pretty impressive for investing in an instrument that not only pays dividends but grow its capital steadily over time.
Source: Singapore Exchange Website
Why is it share prices perform well?
There’s 3 reasons:
- It’s good to note if interest rates go up, this is will cause property prices to drop, and REIT managers can also take opportunities to buy cheaper properties with a higher yield.
- Rising interest rates positively affect REITs fundamentals. Think about this: people typically see rising interest rates because of better economic growth and rising inflation. Both are actually good for properties. And better economic growth means there’s higher demand for properties. This leads to higher occupancy. And increase in rental.
- All 44 Singapore REITs have average gearing ratio of 37%. Which is still very conservative. Even in a rising rate environment, Singapore REITs can take advantage of loading up more debt to find more opportunities and grow distribution.
Here’s another reason why Singapore REITs tend to perform well over time.
REITs attract conservative income investors who depend on dividends on retirement.
These investors value the stable cash flow and security over anything else.
As long dividends are safe, these investors are unlikely to sell their Singapore REITs even if rates increase.
How to Invest in Singapore REITs
Over the last 15 years, Parkway Life REIT is one of the best Singapore REIT performers.
Why is Parkway Life REIT shares performing so differently? That’s because they have a “built-in rent escalation” formula that allows them to increase rent with rising inflation.
Rising rates come when people expect inflation to go up.
So, in that sense, Parkway Life REIT circumvents the rising rates.
Even though its current dividend yield is low today, it has been growing DPU over time as a result of its rent escalation.
What’s more, Parkway Life REIT has a cheap borrowing cost. They can do this because they own high quality hospital assets in Singapore and Japan that allows them to raise cheap debt.
In fact, the best Singapore REITs continue to grow and provide steady returns for investors over time.
Another example is CapitaLand Integrated Commercial Trust — despite growing shares issuance, CapitaLand Integrated Commercial Trust continued to pay a steady DPU over the last 10 years.
Except for the last two years, where during COVID it has affected its DPU.
Over the last 10 years, CapitaLand Integrated Commercial Trust has continued to pay consistent dividends despite some of the risks of rising rates.
Their revenues have increased and their share prices have traded within a certain range.
During the periods of rising interest rates, CapitaLand Integrated Commercial Trust’s distribution per unit grew steadily over the time period.
But… Not all Singapore REITs are created equal
Not all Singapore REITs are also equally rates sensitive.
If a Singapore REIT keeps issuing shares and the DPU keeps dropping, then it’s a sign that the company is not making enough high quality property investments.
Because it’s raising a lot of capital but not getting the returns they need.
For example, even though AIMS AA REIT grown their total distribution from 2012 to 2021, a closer look shows AIMS AA REIT have grown shares from 634 million to 707 million between 2016 to 2021.
Yet, its total distributable income have dropped from S$73 million to S$63 million last year.
While its DPU fell from a peak of 11.35 cents per unit to 8.95 cents per unit.
One big reason for this is because the quality of assets isn’t very strong. It wasn’t able to consistently grow revenues over the last few years.
What’s more, logistics is a highly competitive space. And the REIT still has to deal with decaying land leases — don’t forget, industrial properties in Singapore only have a 30 years lease before the land lease expires.
Source: AIMS AA REIT FY2022 Presentation Slides
What you want to do is this:
- Avoid REITs with a huge debt.
- Avoid REITs that pay very high borrowing costs
- Look for REITs with rental agreement that allows rent to increase together with rising inflation. So as interest rates go up, rent rises.
- Invest in REITs where management have a good insight on how to source high quality assets, while fighting for cheap borrowing costs. A strong sponsor also helps.
- And invest in REITs that are expanding.
Final Thoughts: Rising Rates on Singapore REITs
The logical conclusion is inflation goes up, interest rate goes up. Singapore REITs can also produce higher rents with the rising inflation and better economic outlook.
This raises dividends and share performance over time.
REITs aren’t a bad investment idea in rising rates.
But what I’ll say is picking the right REITs is important.
And that’s the other thing, for Singapore REITs there’s little relationship between share price performance and interest rates movement over the last 20 years (see Lion Global Investors chart above).
If interest rates go up due to a growing economy and higher inflation, actually stronger REIT fundamentals may outweigh negative impact caused by rising rates.
This gives Singapore REITs good opportunities.
Because higher interest rates tend to depress property prices. A high quality manager can buy up properties at a reduced price — Buy low, sell high.
Of course, the caveat here is you need to have a strong management team, to be able to source for good properties.
That’s why, in a rising rate environment, not all REITs are equally sensitive to rising rates.
Sometimes, investing can be simple.
Willie Keng, CFA
Founder, Dividend Titan