It’s has been a heartbreaking year for investors who invest in REITs. Many investors who had listened to analysts and bloggers saying that it is time to buy REITs thinking that inflation has came down in the US to below 3% and that the Fed will start cutting rates have been so wrong.
Though back in September, the Fed has finally cut rates by half a percentage point after holding them at their highest level in 23 years, REITs share price did not respond positively.
Instead, after the Fed rate cut on 18 Sep 2024, the FTSE REIT index dropped more than 11% to the current level of 642 points. I have said many times in my articles that inflation will remain sticky and true enough inflation in the US stayed stubbornly above Fed 2% target.
In fact, the 10 year treasury yield has risen to the current level of 4.6% reflecting this scenario and that the Fed has to cut rates fewer times.
How REITs are affected by interest rates
In general, REITs are negatively impacted by higher interest rates as they are highly geared and rely on debts to finance acquisitions to grow DPU.
However, with higher interest rates, the REITs interest expense will increase and will result in lower distributable income as well as DPU. This in turn will result in lower share price for REITs.
For example, in 2Q FY24/25, MLT borrowing cost increase by 8.2% to S$39.8 million. The higher borrowing cost is one of the contributing factor that resulted in lower DPU. You can view the REIT website here.
Interest Rate Dilemma
I have said in my previous articles that when investing in REITs look at the 10 year US treasury yield. As long as it remains above 4%, REITs will be impacted by higher financing cost and hence resulting in lower DPU and the REITs share price will remain depressed.
Many investors now have an interest rate dilemma and must be wondering should they cut loss on their REITs or should they continue to hold REITs as the share prices have fallen to very attractive levels? It really depends on the individual investor and they have to make their own decision.
However, in my opinion, the following scenarios are likely to play out especially after 2nd half 2025 and year 2026:
- Stagflation like the 70s. Inflation will remain sticky in the US and the US enters into a recession;
- The US enters into a deep recession and all assets prices will fall;
- Soft-landing for the US economy. This is highly unlikely and most likely will be scenario 1 or scenario 2.
Given the above scenarios I have outlined, investors will be facing an interest rate dilemma whether to continue to be vested in REITs.
Disclaimer: Please note that the REITs mentioned in this article are not a financial recommendation to buy and investors need to do their own research and due diligence before investing in any of these REITs.
