One of the things that keep retail investors away from REITs at the moment is the impact of rising interest rates on distribution (also known as dividends, but it is referred to as ‘distributions’ in REITs) payouts.
For those who are new to investing, you may be wondering how is it so – you see, as REITs are mandated to pay out 90% of their taxable earnings as distributions to qualify for tax exemptions, whenever they need to embark on acquisitions (which is the quickest way to grow their revenue), they will need to borrow money to do so. With interest rates at much higher levels currently (as a result of a series of interest rate hikes by the Federal Reserve for the whole of 2022), the REITs management have drastically reduced acquisition activities so as to avoid being over leveraged – that said, revenue growth will slow, and so too will the growth of distribution payout to unitholders.
Not just that, REITs are also faced with rising interest costs for the existing borrowings (if they are not being hedged at fixed rates) – this will also see distributions being negatively impacted as well.
That being said, in a situation like this, my opinion is that REITs with a higher percentage of borrowings hedged at fixed rates (my ideal is 80% and above), along with a low percentage of borrowings due from now till end of calendar year 2025 (why 2025 you may ask – that is because I foresee interest rates to come down to more manageable levels only by then) will have their distributions less impacted compared to those that don’t.
What I’ll be doing in this post is to share with you a simple analysis that I’ve done to find out the extent in which distributions by the 9 REITs I’m invested in (you can view my long-term portfolio here) will be impacted by the current high interest rate environment, by taking a look at their debt profile as at 31 December 2022 (I will be looking at 3 statistics in particular – its aggregate leverage, percentage of borrowings on fixed rates, and approximately how much [in percentage terms] of borrowings will be expiring from now till the end of calendar year 2025):
|% of Borrowings|
Hedged to Fixed
|% of Borrowings|
Due for Refinancing
from Now till
My Observations: As you can see from the table above, all 8 REITs have a certain percentage of borrowings due for refinancing from now till end-2025. However, I noticed that both CapitaLand Ascendas REIT, as well as Keppel DC REIT, have less than 30% of their borrowings (which is the least among the 8 REITs) due for refinancing from now till end-2025 and with that, they will be more ‘shielded’ from the negative impacts of high interest rates. On the other hand, EC World REIT have all of its borrowings due for refinancing from now till end-2025 – in fact, a huge percentage of its borrowings will be due for refinancing on 30 April 2023, something which I’m keeping a very close watch on.
In terms of impact on distribution rates in the near-term, I’m of the opinion that those with a higher percentage of borrowings hedged at fixed rates will be more ‘protected’ than those without – in that regard, I noticed that CapitaLand Ascendas REIT, CapitaLand Integrated Commercial Trust, Mapletree Logistics Trust, as well as Mapletree Pan Asia Commercial Trust have close to 80% (or more) of its borrowings hedged to fixed rates, hence providing a certain level of income stability for unitholders.
Finally, while the REITs management may be less willing to embark on acquisition activities during this period, but in my opinion, if they were to come across a ‘value for money’ deal that is yield-accretive to unitholders, they will still embark on them (look at how the management of Frasers Centrepoint Trust still proceeded with a 25.5% stake of nex – a retail mall in the heart of Serangoon – I view the transaction as a positive one for the REIT, as it further cements itself in the suburban retail mall market. You can read the news about it here.) Hence, those with a lower aggregate leverage (particularly those at or below 40.0%) will have more debt headroom to embark on such activities than those with a higher aggregate leverage – in that regard, I’m happy to note that all the REITs I’m invested in (with the exception of Suntec REIT, where its current aggregate leverage is at the ceiling already, as the regulatory limit for them is at 45.0% due to its interest coverage ratio being under 2.4x) have their aggregate leverage maintained at 40.0% and lower.
Among the 8 REITs I have units in, it seems that CapitaLand Ascendas REIT is very likely to be least impacted by the high interest rate environment – as it has a very low percentage of borrowings due for refinancing from now till end-2025 (at just 28%), a very high percentage of borrowings hedged at fixed rates (at 79.4%), and at the same time, its aggregate leverage is at a very comfortable level (at 36.3%) – providing it the flexibility to embark on acquisition activities when an attractive one comes along its way.
At the other end of the spectrum, I’m closely monitoring the refinancing status of EC World REIT (what is most worrying is that from the announcement on 28 February, I note that the purchasers of the 2 properties which the REIT is divesting to is still in the midst of securing funds to do so; furthermore, I note there is no guarantee that the lenders will grant the REIT further extension to repay 25% of its borrowings beyond 28 February – at the time of writing, I’m still awaiting for the REIT management’s response to my email query sent yesterday.) Another one is Suntec REIT, where I have mentioned earlier that its aggregate leverage (at 42.4%) is already at the ceiling, and I note from the REIT’s management they are looking at divesting some properties in Australia to repay some of their borrowings and bring down their aggregate leverage – I await further announcements on this front, but do note that upon any divestments, the loss of income from the divested properties will mean a decline in distributions to unitholders.
With that, I have come to the end of my short share today, where I looked at the level of impact that REITs I have investments in will be affected by the continued high interest rate environment. Please note that the information presented is for educational purposes only, and they do not represent any buy or sell calls for any of the REITs mentioned. You’re strongly advised to do your own due diligence before you make any investment decisions.
Disclaimer: At the time of writing, I have investments in all the 9 REITs mentioned in the post.
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