Begging the question, are REITs doomed? It is fitting to have this in our minds recently, with a number of Singapore-listed REITs (or S-REITs) going to the very lows for, at least, the past two years. According to the iEdge S-REIT Index1, the freefall started sometime in August 2022, after a period of zigzagging that occupied much of the period from June 2020.
Yet, if we look back a little further in the same index, the elephant in the room is the massive drop between February and March 2020. We knew what happened during this time, but very few people were harking that REITs are doomed (on the contrary, the famous panic line uttered was “everything is doomed”, or some variations of it). The difference between then and now is attributed to two of the common investment biases at play, which are recency and anchoring, and the main fuel is, of course, interest rates.
Interest rates, as I had written a few times (here and here, to name a couple) have a profound effect on the entire market and economy. The ripple effects of rising interest rates, ceteris paribus, will lead to higher cost of debt and, in a more long-winded fashion, preference for short-term bonds and bank deposits as the go-to choice of parking one’s capital (which I will go into later). This would result in REITs getting hammered (or doomed) as the asset class is associated with being sensitive to interest rates, since they are usually geared and their seemingly-so high yields are challenged by very safer instruments.
Which is why the recency and anchoring biases are at play here.
Headlines and topics from financial media, blogs, forums, etc., were constantly harping on REITs and their generic inverse relationship with interest rates in the past few months. Obviously, being bombarded with this news and information, it would be occupying our brains for a while. This is recency bias. Closely following is anchoring bias, where investors would (usually) base on the assumption of higher interest rates equates to bad omen for REITs.
A Business Times report on 15 March 20222 stated that close to 75% of S-REITs’ current debts are either on fixed rates or hedged through floating-to-fixed interest rate swaps. This meant, in general, that high interest rates do not really impact much on the debt profile, at least in the short term. Provided high interest rates do not prevail for the next three years or more, this aspect is somewhat mitigated by the S-REITs.
Speaking of the narrowing REIT risk premium (i.e., the difference of yield between REITs and a safe-haven asset) due to rising short-term bond and bank deposit rates, from some investors’ viewpoints, for REITs to be competitive with a current yield rate akin to short-term bonds and bank deposits, REIT prices would need to go down, and very low down. Though we know going to zero is almost impossible, but for some REITs they represent a very huge discount to their respective book values.
Although such safe instruments are in vogue, one must remember that only a few years ago, their yield and rates were considered low by many investors, and (you guessed it) people flocked to REITs. The lesson here is obvious: for any financial instrument, every day is not a Sunday.
Frankly speaking, REITs looked appetizing now.
Now the big counter question cometh: what am I going to do?
A few things that you need to know and do. On the “know” part, as I had stated above, there are no “forever Sundays” financial instruments (and asset classes/regions and countries/sectors and industries). On a related note, there are no “forever Mondays” in economic conditions, too, as we all know at the back of our brains that things will get better, sooner or later. For this, “do” diversify; going into your investment portfolio on a well-diversified basis would at least provide lesser losses than a concentrated one.
On interest rate hedging employed by the S-REITs, while it is done on a whole front, it pays to read further each REIT’s debt profiles, which are available from their annual reports and presentation slides, and factor into your fundamental analysis. If this is not your investment style (i.e., passive), then consider going into one of the five REIT ETFs available (which I had shared a bit here).
While writing this, I had read about the hints on lowering future rate hike numbers. This may spell good news for REITs in general. So, they may not be doomed at all?
1 – iEdge S-REIT Index. SGX. https://www.sgx.com/indices/products/sreit (accessed 22 Oct 2022).
2 – Li, Candace. S-Reits hedge against rising interest rates. The Business Times. 15 Mar 2022. https://www.businesstimes.com.sg/companies-markets/s-reits-hedge-against-rising-interest-rates (accessed 22 Oct 2022).