In the financial markets, interest rates significantly influence virtually all assets. More specifically, the interest rate set by the United States central bank – the Federal Reserve (Fed) – serves as a crucial benchmark for global asset prices. This influence is largely attributable to the dominant role of the US Dollar in international financial markets and capital flows.
When the Federal Reserve adjusts interest rates, it directly impacts the cost of capital. As interest rates rise, so do the borrowing costs because the risk-free rate of return – typically represented by US Treasuries – increases. This cascade effect leads to higher lending rates and alters the investment landscape.
The real estate investment trust (REIT) sector is particularly sensitive to these changes; this impact is especially pronounced in Singapore. The Singapore Exchange (SGX) hosts a robust REIT market, which, as of the end of April 2024, constituted approximately 12% of the entire listed stock market in Singapore.
Investors need to recognise that the past few years have been challenging for Singapore’s REIT sector. The upward adjustments in US interest rates have ripple effects, influencing S-REITs’ performance and attractiveness.
Higher Rates Impede Ability Of S-REITs To Grow
As interest rates rise, the cost of debt increases, directly impacting S-REITs’ ability to raise capital for acquiring new properties. For REITs globally, growth in distributions (or dividends) to unitholders typically hinges on two primary strategies:
Acquiring new properties
Achieving positive rental reversions (i.e., securing higher rental rates)
However, higher lending costs have significantly constrained the capacity to raise new debt for property acquisitions. This challenge is further compounded by the attractive returns local investors can now achieve through Singapore Treasury bills (T-bills), which offer close to 4% per annum (p.a.).
Since T-bills are considered the risk-free rate in Singapore, REITs listed on the Singapore Exchange (SGX) must naturally yield considerably higher returns to attract investors. The need for competitive yields means that S-REITs face heightened pressure to deliver superior performance amidst rising interest rates.
Cost Of Debt Still Weighs On S-REITs
Meanwhile, the average cost of debt for S-REITs has risen. Take, for example, Mapletree Logistics Trust (SGX: M44U), which reported a weighted average annualised interest rate of 2.7% as of 31 March 2024. This increased from 2.2% three years earlier, as of 31 March 2021. Although this may appear to be a modest increase, it represents a significant rise in borrowing costs.
Over the 12 months ending 31 March 2024, Mapletree Logistics Trust experienced an 8.8% year-on-year increase in borrowing costs, reaching S$145.9 million. While this is just one example, it highlights the broader challenges S-REITs face.
During the COVID-19 pandemic, many S-REITs issued debt at relatively low interest rates, with varying maturities. As this older, cheaper debt matures and is refinanced at higher rates, the debt burden for S-REITs is expected to increase. This trend is closely tied to the interest rate policies the US Federal Reserve set.
Impact On Distributions To S-REITs Unitholders
As the cost of servicing debt rises, the amount of profit available for distribution as dividends decreases. This has become evident to investors, as many have started to see a reduction in distributions paid out by S-REITs. According to data compiled by The Business Times, in the second half of 2023, 28 S-REITs experienced a decline in their distribution per unit (DPU), with the median DPU decline being 8%.
Source: Business Times, company announcements
Despite higher revenue and net property income (NPI) figures reported by many S-REITs, these gains have been offset by increased financing costs. This is crucial for investors to understand, as it directly impacts the returns they can expect from their investments in S-REITs.
Talk Of Fed Rate Cuts Boosts Sentiment For S-REITs
A common theme for investors is that any speculation about sooner-than-expected rate cuts in the US tends to boost interest in S-REITs. This is because the prospect of lower borrowing costs makes REITs more attractive, given the potential easing of their debt servicing burdens.
For instance, last November, when the US Federal Reserve signalled that rate hikes might be over, the unit prices of S-REITs rallied. The iEdge S-REIT Index delivered positive total returns of 7.4% in November 2023, marking its highest monthly return since November 2020, when it achieved a 7.5% return.
Looking Towards Higher Rate Environment
The outlook of sustained higher interest rates from the US Federal Reserve has continued to weigh on S-REITs. At the beginning of 2024, the market anticipated at least two to three interest rate cuts, encouraged by positive inflation data. However, recent developments have altered these expectations. Strong economic growth in the US and stalled progress on reducing inflation have led financial markets to now expect only one interest rate cut in 2024, with many commentators predicting no cuts until 2025.
As a result, the iEdge S-REIT Index has declined, approaching multi-year lows by April 2024. This highlights the ongoing impact of US Federal Reserve monetary policy on the fortunes of Singapore REITs.
Understanding the dynamics of US Fed policies is crucial for investors in S-REITs, as these policies are likely to continue pivoting the sector’s performance.
Read Also: How Does the Fed Not Cutting Interest Rates Impact Your Financial Lives?
Image By Jason Goh from Pixabay
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