Thursday, 3 October 2013

S-Reits insulated from rising rates?

The impending rise in interest rates has bruised the value of Reits listed on the Singapore bourse, but Moody's said the ill effects will be minimal.

The following is excerpts from the report:
The 13 Singapore Reits that have credit ratings are largely insulated from higher rates over the next year, said Moody's Investors Service, because they have a high portion of fixed-rate debt and not much need to refinance their borrowings.These Reits have more than half their debt tied to fixed interest rates. They also have longer debt maturities compared with five years ago: the average maturity is now 31/2 years, from about 21/2 years in 2008.

Only 18 per cent of the total debt of the 13 Reits will be due in the next 18 months. Frasers Commercial Trust has the largest share of outstanding debt - 36 per cent - coming due but Moody's believes the Reit's "track record suggests it will be able to refinance its maturing debt". Of the 13 rated S-Reits, Frasers Commercial Trust and Suntec Reit are the most exposed to a rise in interest rates. The former has only 51 per cent of its debt at fixed rates, while the latter has 60 per cent.At the other end of the spectrum, the Reits least likely to be hit by rising interest rates are Frasers Centrepoint Trust, which has 94 per cent of its total debt on a fixed-rate basis, and Saizen Reit, which has 85 per cent, it added.

Another way to measure the effect of rising rates is to gauge which Reits would see the biggest increase in their debt servicing costs. These would tend to be Reits that currently have low interest expenses, Moody's said. Reits in this group would include Mapletree Greater China Commercial Trust, Keppel Reit and Mapletree Commercial Trust.
But Moody's said these Reits may have mitigated the rate risk by locking in fixed rates and extending their debt maturities.In addition, Moody's pointed out that while higher interest rates raise borrowing costs, they "also reflect an improving economy and growth prospects". This will give S-Reits, especially those in the office and hospitality sectors, the potential to raise rents and occupancy, it said.

The report above reads like a scoreboard for S-REITs with credit ratings. It does not mention the rest S-REITs without credit ratings. Nor does it imply that S-REITs without credit ratings are more prone to the ill effects from interest rise. Instead, the report mainly aims to highlight that most S-REITs with credit ratings are in a good position to face the impending interest rate rise. The main message sounds reassuring.

Indeed, interest rate rise will affect REITs mainly in two ways.
( Pls see earlier post " As dust settles, value emerges?", increase in interest expense and refinancing risk reduce the profits, Secondly, asset value is affected by re-pricing process caused by higher risk-free rate. This is bad as decreasing property value reduce the fundamental value of REITs. It also pushes up leverage, causing even more difficulties for financing and refinancing. But real estate value also depends on the economic cycle.  As the report pointed out, higher interest rates also reflects improved economy prospects, as Fed has made it explicitly clear that QE will taper off only after economy recovery is confirmed, let alone interest rate rise.

Hence, it does not mean that when interest rate goes up in future, property price goes down. It is not a simple linear relationship. If the interest rate rise is due to improved economic outlook ( e.g. US unemployment rate keeps improving), then property price should hold steady and rise up. This is true in history. Asset prices usually go up during booming economic cycle, while the interest rate also gradually goes up. The real estate transaction volume may drop since higher interest cost affect potential buyers' financial leverage power. But as long as the existing owners can and are willing to hold on to their property(that is to say the rental increase exceeds interest cost increase), you will not see the price drop much.  What if the interest rate rise is due to inflation hike? ( Fed indicated to end expansionary financial policy if inflation picks up, even without strong economy recovery).So we have stagflation. History shows that when inflation is up, prices of almost all assets everywhere eventually can only go upward. But in this case, Reits' profitability will not be rosy, but Reits price should inflate(compare to increase), and the the real estate property price susually inflate at a higher rate than CPI. i.e. one is still better off holding asset rather than cash.

Although in recent months, we saw all kinds of yield play instruments (such as bonds, dividend stocks especially the utilities sectors, and REITs) were hit hard since May, we must not forget that REITs is a independent asset class of its own. REITs are proxy to Real Estate investment. They should not be analyzed  the same way as dividend stocks. As a result, REITs suits long term investors with the primary investment goal of steadily increasing income, with long term capital appreciation. The key here is long term, as Real estate market cycle is much longer than that of stock or bond market.  Hence, with the impending interest rate rise, REITs should start to behave differently from other yield plays. Bonds are likely to go south. Dividend stocks may divert according to their own merits. But REITs, as a separate asset class, should exhibit more of its real estate characters.

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