Economists are falling over themselves in their hawkish comments. Goldman Sachs is forecasting that the US Federal Reserve will raise interest rates five times in 2022, versus four previously, with a hike expected in March. Bank of America economists have suggested they expect the Fed to hike rates by 25 basis points seven times this year. All this is bad news for REITs.
Undoubtedly, with rising risk free rates, REITs’ unit prices have already come under pressure. For instance, the FTSE ST REIT Index is down around 5% since the start of the year. Not surprising. According to SGX Research, the average yield spread for S-REITs in the past 10 years is 3.99%. As at Feb 8, the yield on 10-year Singapore government bonds is 1.87%, and on 10- year Treasuries 1.94% (see chart), and rising.
On Feb 9, Bloomberg reported that the 10-year Treasury yield climbed to 1.96%, “levels last seen in 2019, with some investors betting it’s heading for 3%”. The trend of the yield on 10-year Singapore Government bonds is closely correlated, and that would imply an average DPU (distribution per unit) yield of around 7% for the S-REITs compared to 6% currently (based on the average in the table). If the yield spread needs to remain at around the 3.9% to 4% levels, then REIT unit prices would need to fall to compensate for the expansion in yields.
The yield spread is the difference between risk-free rates, which are usually the yield on 10-year bonds, and REIT yields. As risk-free rates continue to rise, they may continue to pressure REIT unit prices.
On the other hand, some analysts reckon that the sell-down offers a buying opportunity for investors. “In view of the impending rate liftoff in March 2022, we believe that we are nearing the near-term bottom for S-REITs, with the sector also having hit the bottom in prices back in March 2016 after rates were last raised. We are, therefore, not sellers at these levels, but are looking for an opportunity to accumulate upon the weakness,” wrote DBS Research in a report dated Feb 3.
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
Whether the sell-down represents a buying opportunity is something that investors need to decide for themselves, as the extent of inflation and the Fed’s wherewithal to suppress it are unknown factors.
Some of the S-REITs have experienced the global financial crisis (GFC), when interest rates spiked, capital values fell, and the great recession set in till the troubled asset relief programme or TARP kicked off along with quantitative easing.
Operationally resilient
See also: CICT's manager proposes to acquire ION Orchard at $1.85 billion, subject to EGM
As a result, REIT managers are sensitive to investors’ perception of interest rates. REIT managers, including those of Keppel REIT, FrasersCentrepoint Trust and the CapitaLand Investment REITs, have announced their REITs’ sensitivity to interest rate movements.
As a case in point, CapitaLand Integrated Commercial Trust (CICT) has to refinance more than $1 billion of debt this year. Of this, $190.1 million is a 10-year bond with a coupon of 3.45% that matures in June this year. A further $75 million is a sixyear bond with a coupon of 2.77% that matures in July.
“Some of the debt to be refinanced is higher than 3%, so we can still get some saving,” notes Tony Tan, CEO of CICT’s manager. “We have sufficient lines to fund the $1.1 billion. It will be fully funded if there is a crisis. We are protected, with 83% of the debt on fixed rates,” he adds.
In addition, CICT’s gearing inched lower to 37.2% because the Australian assets were partly funded with equity, and CICT completed the divestment of its 50% stake in One George Street. However, gearing is likely to rise back to 40% once the Australian acquisitions are completed. On the other hand, gearing could retreat when JCube’s divestment is completed later in 1Q2022.
In a presentation on Jan 28, CICT indicated that every 10bps rise in interest rates could shave two cents off DPU. While the US Federal Funds Rate could rise as much as 1% this year, it is not clear if the flow-through to local benchmarks such as Sibor, Sor and Sora is 100%. Nonetheless, several S-REITs have articulated the impact of these rate rises on their DPU.
Notably, though, there are other parts to DPU. For instance, acquisitions could add to DPU, while upward pressure on utilities could deduct from DPU. In FY2021, CICT’s DPU was 10.4 cents, up from the 8.69 cents in FY2020, which was impacted by Covid. This year, CICT’s DPU is likely to be supported by its Australian acquisitions which have yet to be completed, and which could offset any impact from rising interest rates.
Separately, CapitaSpring has a committed occupancy of 93%, and a further 5% to 6% is in advanced negotiations, Tan says. “More meaningful cash flow will come in, in 2H2022,” he says. Elsewhere, Asia Square Tower Two is signing a major consultancy, and the physical cash flow from its higher occupancy will come in, later in the year, he indicates. Similarly, Six Battery Road’s occupancy is likely to rise to 90% following asset enhancement initiatives. Its Collyer Quay property, which is fully leased to WeWork, is also likely to get its cash flow in, in 2H2022.
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“For office we will see an uplift in new rents predominantly from Capital Tower, where expiring rent was only $5.99 psf, and Six Battery Road. And Twenty-One Collyer Quay has been handed over. We have started receiving revenue but the [actual] cash flow comes in 2H2022,” Tan says.
DPU outgrows rising rate impact
CapitaLand China Trust (CLCT) is in a slightly different position from CICT. It was one of the worst performers in terms of unit price in 2021. However, its DPU growth of 37.4% in FY2021 to 8.73 cents is one of the highest among the S-REITs. Its FY2020 DPU was impacted by China’s shutdown to combat Covid.
Separately, CLCT expanded its madate and acquired five business and tech parks in 2020-2021, and four logistics properties in 2021. Some of these assets started contributing to its FY2021 net property income. Since 77% of CLCT’s debt is on fixed rates, a 0.1% per annum increase in the variable rate means an $800,000 change in interest expense a year. In FY2021, interest expense was at $23.3 million.
“Our debt maturity is well staggered. We are in an advanced stage of refinancing facilities as they come due in 2022,” says Tan Tze Wooi, CEO of CLCT’s manager. Some 20% of CLCT’s debt comprises onshore RMB loans where the People’s Bank of China is on an easing trend compared to the Fed’s tightening. CLCT has relations with a range of local Chinese banks.
Potential for divestment, redevelopment
CLCT has a few malls that have underperformed. These are Qibao Mall on the outskirts of Shanghai in one of China’s old water towns, Aidemengun in Harbin, and Grand Canyon in Beijing. Xinnan Mall in Chengdu is facing competition as there is an oversupply in that city. These malls could be viewed as non-core, and marked for divestment. In Beijing, one of CLCT’s IPO malls, Shuangjing Mall, is interesting because the anchor leases come due in 2024. The property is located in a dense residential precinct.
“It’s in a mature location which is very densely populated with a captive catchment. We are looking at a redevelopment; or we could divest the property with redevelopment potential to buy back when that potential is realised so we don’t have to take downtime in the asset,” suggests Tan Tze Wooi.
CICT, which shares the same sponsor as CLCT, has undertaken the redevelopment of two properties — CapitaGreen and CapitaSpring — in partnership with its sponsor, and this could be a template for CLCT with Shuangjing Mall.
Overall, as CLCT increases its debt profile to onshore loans, its DPU yields should be increasingly tied to China’s risk-free rates, which are likely to trend lower.
Photo: CapitaSpring by CICT
