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Interest Rates Are Surging: Can REITs Still Grow Their DPU in 2023?

Higher Interest Rates Just Ahead
Higher Interest Rates Just Ahead

It’s no secret that interest rates have jumped significantly in just a year.

Last year, the US Federal Reserve raised its benchmark rate by 0.75 percentage points in four consecutive sessions and then added another 0.5 percentage points in December.

These moves marked the fastest pace of rise since the 1980s.

Then, last month, the central bank raised interest rates by another 0.25 percentage points, bringing the benchmark rate to between 4.5% and 4.75%, in a bid to lower runaway inflation.

As a result, REITs have not had it easy as they are leveraged instruments that are sensitive to interest rate increases.

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Higher rates not only translate into higher finance costs that crimp distributable income but also make it tougher for REITs to conduct acquisitions to grow their asset base and distribution per unit (DPU).

With interest rates poised to rise further, can REITs still manage to grow their DPU?

Recent REIT acquisitions

The higher rates have not stymied several REITs’ acquisition attempts.

Last December, CapitaLand India Trust (SGX: CY6U), or CLINT, acquired International Tech Park Pune in India for around S$221.9 million from its sponsor, CapitaLand Investment Limited (SGX: 9CI) and its joint venture partner.

In addition, just last month, CLINT inked a forward purchase agreement to acquire a one million square foot IT park located in Bangalore.

Meanwhile, Frasers Centrepoint Trust (SGX: J69U), or FCT, has also been busy.

The retail REIT partnered with its sponsor, Frasers Property Limited (SGX: TQ5), to jointly acquire a 50% stake in NEX mall in Serangoon.

The heartland mall enjoys nearly full occupancy and has a net property income yield of more than 4%.

From the two examples above, it’s clear that both FCT and CLINT are leveraging their sponsor to conduct acquisitions.

Hence, the presence of a strong and reputable sponsor can help a REIT to negotiate successful acquisitions.

These sponsors may even have a ready pipeline of assets that can be injected into the REIT, eliminating the need for the REIT to source for external acquisition opportunities.

One good example is Keppel DC REIT (SGX: AJBU).

The data centre REIT’s sponsor, Keppel Corporation Limited (SGX: BN4), has more than S$2 billion of potential data centre assets to inject into the REIT.

Managing their debt

Remember that REITs are not sitting ducks when rates surge.

The REIT manager has various methods to mitigate the effect of higher rates, such as locking in a proportion of its loans on fixed rates or having a well-spread-out debt maturity profile.

For instance, CapitaLand Integrated Commercial Trust (SGX: C38U) has 81% of its borrowings on fixed rates.

The retail cum commercial REIT also has its debt maturities spread out till 2033, with just 12% of its loans coming due this year.

Meanwhile, Frasers Logistics & Commercial Trust (SGX: BUOU), or FLCT, has locked in 78.7% of its debt on fixed rates.

What’s more, just 3.2% of FLCT’s debt is coming due in September this year, and the REIT enjoys a very low cost of debt at just 1.7%.

Organic growth initiatives

All is not lost even if a REIT cannot identify suitable acquisitions.

The REIT manager can tap into organic growth initiatives to allow DPU to continue its climb.

These include asset enhancement initiatives (AEIs), positive rent reversions, and built-in rental escalation clauses.

CapitaLand Ascendas REIT (SGX: A17U) completed two AEIs in 2022 worth S$16.3 million in Singapore.

The industrial REIT has an ongoing AEI with an estimated cost of S$15.5 million that should complete by the fourth quarter of 2023.

Mapletree Logistics Trust (SGX: M44U) has once again reported a positive rental reversion of 2.9% for its current fiscal 2023’s third quarter.

The logistics REIT is continuing its run of more than 10 consecutive quarters of positive rent reversion, underscoring the strong leasing demand for its properties.

For Keppel DC REIT, built-in rental escalation clauses embedded within its leases have helped the data centre REIT to offset some inflationary impact.

Get Smart: Where there’s a will, there’s a way

As the above examples illustrate, REITs can still grow their DPU in a variety of ways despite the steadily-rising interest rate.

Savvy REIT managers can choose to lock in a greater proportion of the REIT’s loans at fixed rates or engage in organic growth initiatives to boost DPU.

And if all else fails, REITs with strong sponsors can tap into them for potential yield-accretive acquisitions.

Is it a good time to buy into Singapore REITs? If you’ve thought about it, then our latest REITs guide will be an essential read. This exclusive pdf report shows you why REITs are still excellent assets, what sectors to look out for and how to find good REITs today. The info inside can help you build a solid retirement portfolio. Click here to download it for FREE.

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Disclosure: Royston Yang owns shares of Keppel DC REIT and Frasers Logistics & Commercial Trust.

The post <strong>Interest Rates Are Surging: Can REITs Still Grow Their DPU in 2023?</strong> appeared first on The Smart Investor.