Buying REITs? Here’s Why Interest Rates Matter

July 5, 2021

Interest rates, globally, are at all-time lows yet talk of inflation returning has many investors worried.

It’s currently sitting just 25 basis points above 0%. What does that mean for real estate investment trust (REIT) investors who are in Singapore?

Well, the central bank in the Singapore – the Monetary Authority of Singapore (MAS) – uses the Singapore dollar as way of controlling price stability in the city state.

Yet as an open (and globalised) economy, Singapore is not immune from the monetary policy that comes from the Federal Reserve in the US.

So, here’s why low interest rates are great news for REITs and why, even when interest rates do rise, it doesn’t necessarily spell disaster.

Low rates = yield hunt

In an era of uber-low interest rates globally, investors seem to be on a never-ending search for yield. Basically, that means trying to find a return on your money that is higher than inflation.

Why bother putting your hard-earned savings into a bank (where it yields close to 0%) when you could earn an income from putting your cash into a solid dividend-paying stock?

Worldwide, this is a phenomenon that has been playing out ever since the Global Financial Crisis back in 2008.

Heading into negative territory

The eurozone is a perfect example of this. In Europe, the European Central Bank (ECB) now has a negative interest deposit rate of -0.5% – a policy that has been in place since 2014 to counter the eurozone crisis.

In Japan, the Bank of Japan (BOJ) turned to a negative interest rate policy in 2016 in an attempt to get inflation closer to its 2% target.

So, what do it all mean? Effectively, banks in Europe and Japan pay the ECB and BOJ, respectively, to store their reserves at the central bank.

In an effort to get consumers to spend, the upshot has been that large banks in both have been extremely unprofitable over the past decade.

Good for REITs though

However, lower interest rates are good for REITs. That’s down to a number of reasons. First, borrowing (or leverage in REIT-speak) is how REITs can actually grow their portfolios – mainly through acquisitions.

If they can borrow cheaply and at low rates, maybe even refinancing those loans at even lower rates in the future, then they will have less interest expenses to service and more income to distribute.

In this respect, the largest (and strongest) REITs have the biggest advantage.

Second, with lots of money now in negative-yielding bonds – it was a stunning US$13 trillion globally in 2020 – some of that cash will inevitably find its way to more attractive yield investments. This includes REITs.

Interest rates rising?

So what if interest rates start to rise? As my colleague, Say Boon Lim, has written about, the outlook for bonds in this scenario would actually be much worse than stocks.

And even for stocks, such as interest-rate sensitive REITs, would it be that bad? Look what happened in 2016-2018, when US interest rates actually rose for the first time since 2008.

In fact, they reached a range of 2.25-2.5% by early 2019. Did REIT prices in Singapore collapse? No, they did not.

That’s because rising interest rates doesn’t necessarily spell gloom for REITs. It actually indicates that growth in the US is strong. By extension, that tends to be a positive thing for the rest of the world.

Quality matters

However, it will be important for investors to discern between REITs. Will certain types of REITs do better in the region than others?

So far during Covid-19, it has been clear that retail-focused REITs (that rely on shoppers and footfall) have taken the brunt of the coronavirus-induced sell-off.

Furthermore, they had to retain a lot of distributable income for potential support to hard-hit tenants in the early part of the crisis.

Meanwhile, other REITs focused on logistics and industrial properties have actually held up well while also continuing to pay out dividends.

Focus on longer-term trends

Finally, if you’re a believer in the growth of real estate in Asia and its importance to the functioning of economies then REITs offer a great and liquid way to gain exposure while also earning income.

The growth of the REIT market in Singapore, which saw its first listed REIT back in 2002, has seen investors bet on the long-term appreciation of real estate assets in the region.

The bottom line for any dividend investor in REITs is to look at the fundamentals of the business and how management foresees its growth.

For the long-term investors focused on income though, one thing is certain; dividend-paying investments are here to stay.

Tim Phillips

Tim, based in Singapore but from Hong Kong, caught the investing bug as a teenager and is a passionate advocate of responsible long-term investing as a great way to build wealth.

He has worked in various content roles at Schroders and the Motley Fool, with a focus on Asian stocks, but believes in buying great businesses – wherever they may be. He is also a certified SGX Academy Trainer.

In his spare time, Tim enjoys running after his two young sons, playing football and practicing yoga.

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