What will be the Impact of Impending Interest Rate Hikes on S-REITs?

What will be the Impact of Impending Interest Rate Hikes on S-REITs?

Coronavirus (later known as Covid-19) first started off as a healthcare crisis, but it swiftly deteriorated into an economic crisis, as countries around the world implemented varying degree of lockdowns to slow down the spread of the virus in the community (which drastically impacted economic growth.) The Federal Reserve Board also announced a series of interest rate cuts – where interest rates were being lowered to near zero, to minimise the impact on the economy. The moves, made over the past couple of quarters of 2020, saw the 3 Singapore-listed banks’ (in DBS, UOB, and OCBC) net interest margin recording declines (since the second quarter of 2020), resulting in their net interest income being negatively impacted.

This post was originally posted here. The writer, Lim Jun Yuan is a veteran community member and blogger on InvestingNote, with a username known as @ljunyuan and has close to 2,000 followers.

A couple of vaccines were later developed and distributed – and countries around the world started to inoculate their population. Fast forward to today, many of them are already starting to slowly reopen and resume their economic activities when they achieve their vaccination targets. The Federal Reserve Board have also recently announced (on 03 November 2022) that they will start to reduce the pace of asset purchases from December 2021 till mid-2022 (where their goal is to have no new net purchases by then.) While they have insisted that they do not plan to increase interest rates in the near-term, but it’s inevitable that as normalcy gradually resumes and business activities slowly go back to pre-pandemic levels, the Federal Reserve will make the announcement to do so (my smart guess that an official announcement on interest rate hike may happen sometime towards the end of next year, and whether or not it will really happen will very much depend on the Covid situation then, and also the extent to which economic activities have recovered.)

With that in mind, a friend of mine asked me the following question, “What will the impact of impending interest rate hikes on S-REITs (short-form of a REIT listed in Singapore), and will their unit prices tumble as a result?”

I felt that the question was an interesting one, and that, apart from my friend, many of my readers may also like to know my thoughts about this – as such, I’ve decided to pen down my response to this question in a post today – first, I’d be talking about the extent to which the S-REITs may be impacted by the interest rate hikes; next, I’d be sharing my thoughts on whether or not the unit price of the S-REITs will see some volatility when it happens.

Impact on Interest Rate Hikes on S-REITs:

On the impact of interest rate hikes on S-REITs, my opinion is that some will be worst hit than others – particularly those that have a high aggregate leverage (or gearing ratio as some REITs would like to call it) of more than 40.0%, coupled with those that have a low interest coverage ratio (which measures a REIT’s ability to service its interest payments) – especially those below 3.0x.

If you have been following my reviews on the quarterly updates provided by the REITs I have investments in, you’re probably aware that personally, my preference is towards those that are able to maintain their aggregate leverage at below 40.0% (the reason is because even if the interest rate were to go up, and leading to the aggregate leverage increasing, there’s still sufficient debt headroom before this particular financial ratio reaches the regulatory limit of 50.0%); also, in terms of interest coverage ratio, my preference is towards REITs that are able to maintain it at 5.0x and above over the years.

That said, however, REITs that have a huge amount of borrowings hedged at fixed rates (upwards of 75.0%, along with interest rates at low levels) will be less impacted compared to those where most of their borrowings are at floating rates (meaning their interest rate will fluctuate over the duration of their debt obligation – when the interest rate goes down, they will pay lesser in terms of interest; on the flip side, when the interest rate goes up, they will need to pay more in terms of interest – and this will lead to its aggregate leverage and interest coverage ratio being impacted.)

Impact on Interest Rate Hikes on S-REITs’ Unit Prices:

I personally feel that, in the short-term, any official announcements on interest rate hikes may see the unit prices of S-REITs being negatively impacted – with those having a high aggregate leverage and a low interest coverage ratio seeing their unit prices being more negatively impacted compared to those that have managed to maintain a healthy aggregate leverage and a high interest coverage ratio.

Also, in case you’re wondering if it may be a good time to “bargain hunt” on the S-REITs when the time comes, personally, for those in my long-term investment portfolio that have maintained a desirable debt profile (i.e. with their aggregate leverage maintained at below 40.0% and interest coverage ratio at 5.0x and above), on top of them recording a resilient financial performance and having a good portfolio occupancy profile (where the occupancy rate of properties are more than 90.0% filled), I will be taking this opportunity to increase my unitholding at lower prices (and in so doing, bringing down my average invested price for the REIT, and at the same time, bringing up the distribution yield.)

Closing Thoughts:

That rounds up my response to the question on the impact of impending interest rate hikes may affect S-REITs, along with their unit price movements.

Having said that, please note that all the opinions you’ve just read about in this post are purely my own, which I’m sharing for informational purposes only. If there’s anything you’d like to share about this topic, please feel free to share them either in the comments box below, or if you prefer, you may send me a private message via email as well here.

Once again, this article is a guest post and was originally posted on Ljunyuan‘s profile on InvestingNote. 

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