How will higher interest rates affect REITs?

SINGAPORE (July 9): Real estate investment trusts as measured by the FTSE ST Real Estate Investment Trust Index have fallen by 6.6% since the start of the year despite a rise in the yield of 10-year Singapore Government Securities — from 2% at the start of the year to around 2.5% currently. A strengthening US dollar is likely to exert upward pressure on the Singapore Interbank Offered Rate (Sibor) and the Swap Offer Rate (SOR) and these will continue to have an indirect effect on the 10-year SGS yield, which some market observers expect to rise towards the 2.8% to 2.9% range.

Unit prices of REITs are based on a yield spread, which is the difference between their historic and forward yields versus the risk-free rate. With risk-free rates rising, some focus has fallen on the outlook for REITs given their interest-rate sensitivities.

“If you look at a 15-year average [yield spread], it is typically 3.7% to 3.8%. Just on the basis of the average spread versus current spread of 3.6% to 3.7%, it’s not a good time to bottom-fish across the sector. On the other hand, REITs are also not going to see a significant selloff given the flattening yield curve,” says Brandon Lee, an analyst at JPMorgan (see Charts 1 and 2). 

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