Thirdly, the impact is on valuations as risk-free rates and policy rates have an indirect impact on discount rates which are used to assess assets of REITs in a discounted cash flow model. The higher the discount rate, the lower the capital value, unless these higher discount rates are offset by higher cash flow levels and rents. This has happened for hospitality and lodging assets. The rents of office REITs have been resilient and that too has kept valuations stable in Singapore.
Interest rates affect S-REITs in three main ways. Firstly, the yield spread impacts pricing. As a hybrid between a yield instrument and equity, the immediate sensitivity of S-REITs to risk-free rates is through the yield spread between the S-REITs’ historic yields and the yield on 10-year Singapore Government Securities. (see chart)
Secondly, interest rates affect interest cost, the highest expense item for S-REITs. Given that most S-REITs have announced aggregate leverage levels of more than 30%, with heavyweight REITs such as CapitaLand Integrated Commercial Trust (SGX:C38U
) ’s aggregate leverage rising above 40%, interest costs going into 2024 are unlikely to fall.
