It’s finally here; not only has the Fed hiked interest rates by a quarter point, it has also signaled for further increases should inflation fail to dissipate.
This means that we will likely see a couple more rate hikes within the year. With inflation running hot, the Fed needs to transition to the brakes in order to prevent the economy from overheating.
In fact, we have economists predicting anywhere from 4 to 6 interest rate hikes within the year. And a delicate balance to achieve.
While such hikes do affect stocks one way or another, perhaps the more worrying recipient would be REITs. With a business model centered on owning income-producing properties through debt, REITs are very much in the line-of-fire.
Luckily, when we look back at history, we know that rising interest rates are not the end of the world for REITs. Other factors do drive returns, such as supply & demand, operating industry, and asset quality.
However, the relationship between interest rates and REITs tends to be more direct and causal. Which is why we are looking at it today.
To recap, interest rates affect REITs in various ways. At its core, higher rates increase the REIT’s cost of owning properties due to leverage. This will in turn translate into lower property income, as more cash is diverted to pay for loan interest.
The end-result? Lower dividends for REIT investors
Higher interest rates also level the playing field when income-producing assets such as REITs are placed alongside Bonds. This generally makes REITs less attractive, as income-investors can generate more income through other assets, with lesser risk
A Bird’s Eye View
We went and consolidated the information for various SG REITs into a chart. Should be much easier to compare the various metrics here.
When you combine the Fixed and Floating debt portions, you’ll get 100%, which represents the amount of debt a counter has. While fixed debt tends to be more straightforward, floating rate debt will likely increase in tandem with higher rates, impacting the REIT.
For Cost of debt and Leverage, the lower, the better. REITs with lower overall debt won’t need to worry too much about rising rates, especially if they have a high Interest Cover as well.
The Takeaway? REITs with higher Cost of debt, portion of Floating debt, and Leverage will likely be impacted by rising rates.
But don’t start the selling just yet. The good news is that the impact to DPU will likely be quite small.
Unless the Rate hikes start to snowball that is.
What’s a REIT comparison without dividends? Here you can view each REIT’s annual dividend yield as well. The pricing next to the name reflects the current price of the stock for reference.
It’s better to balance good yields with solid balance sheets of course. Doesn’t make sense to chase yields just to get impacted by rising rates.
We haven’t even added Rental reversions, NPI growth, Future supply, and Industry pricing trends into the mix yet. All of which are pretty important if you’re intent on mastering REIT investments.
Tip Of The Iceberg
While Interest rates and Leverage are important factors, we know they do not make or break an investment in REITs.
The fact is that most SG REITs have been positioning themselves for upcoming rate hikes, and are well-equipped and covered to handle them.
And higher rates normally are caused by better economic indicators, which in this case is inflation. In such a situation, REITs who are in the right industries will definitely feel the positive side-effects.
Hopefully the upcoming rate hikes will be able to get Inflation under control. Otherwise we can expect much higher interest rates to follow.
While a quarter point increase won’t affect REITs much, a 2-3 percent increase, especially in quick succession, could be a very different story.