Risk-free rates are rising with Credit Suisse expecting 10-year Treasury yields to rise to 2.2%, impacting REIT unit prices
A Credit Suisse report dated Jan 24 has shone a spotlight on the impact of the yield spread on prices of S-REITs. REITs are priced off risk-free rates based on a yield spread. Risk-free rates are rising. CS says that the yield spread based on its data of 3.6% is close to 1-standard deviation (SD) above the five-year historical average. While some S-REITs have buffers against rising rates, and S-REITs in general have declined from their highs, the sector could still be prone to near-term volatility as previous cycles suggest that a more sustainable recovery only comes after bond yields have peaked. CS expects US 10-year bond yields to rise to 2.2% (from 1.87% currently).
The US Federal Reserve’s tone was increasingly hawkish in 4Q2021. Economists are forecasting four rate hikes, starting in March.
In addition to impacting S-REITs’ unit prices, “operationally, higher rates will impact the funding cost (higher borrowing cost and lower valuation for equity raising), making it more difficult to drive accretive acquisitions” CS says. It points out that industrial REITs have been the biggest acquirers and will be most impacted. “Interest expenses will also increase, however, we note that 55-95% of debt is fixed, and hence the impact will vary. We estimate that every 25bp increase in interest rates result in 0.1%-4.4% impact on the REITs CY2022 DPU, with Suntec REIT and CDL Hospitality Trusts among the most sensitive under our coverage,” CS says.
Suntec REIT’s portion of debt on fixed rates was 58% as at Sept 30, among the lowest. In addition, its interest coverage ratio is among the lowest while its aggregate leverage is one of the highest among the S-REITs. Although 61.6% of CDL HT’s debt is on fixed rate borrowings, 41.3% or $458 million matures this year based on business updates for 3QFY2021.