Can REITs be a hedge against rising interest rates?
OVER the past 20 years, real estate investment trusts (REITs) have become the global standard for holding investment-grade, publicly traded real estate.
More than 35 countries, including all of the Group of Seven countries, have introduced REIT-type legislation to encourage investment in real estate.
Investors in REITs have been rewarded with strong risk-adjusted returns, both on an absolute and relative basis.
However, we are now witnessing a perfect storm as the world emerges from a series of punitive pandemic lockdowns that have led to major global supply chain disruptions, an unexpected conflict in Ukraine and a sharp rise in l ‘inflation.
The US stock market is off to a rocky start in 2022.
The S&P 500 index, which is widely considered the primary benchmark for U.S. stock market performance, fell 13.3% through April, the biggest four-month drop since 1939.
The index continues to fall in May and was down 16% year-to-date as of Tuesday’s close, approaching the 20% threshold that some investors see as confirmation of a bear market.
We have to be aware that the United States went down due to Covid lockdowns, but quickly recovered and started a strong surge.
However, inflation and the rise in key rates spoiled the party.
In Malaysia, we have seen some sectors perform well despite the pandemic.
Global demand for glove and palm oil prices pushed glove and plantation stocks higher, banks held steady, but the real estate market was hit hard.
M-REITs have not been spared either and many have seen their share prices fall by double digits in response to the effects of the extended lockdowns on their dividend performance and are now trading at historic lows.
Last month’s 25 basis point hike in interest rates didn’t help confidence either.
Is it time to start adopting a defensive strategy and viewing REITs as an investment in times of rising interest rates and high inflation? I think so and I’ll give you four reasons why REITs can weather a recession and provide investors with a safe haven in these volatile times.
For the price of a single share, you can take advantage of dividend payments which, by law, must equal or exceed 90% of the REIT’s taxable income.
These dividends can often more than offset any pressure on REIT stock prices, producing above-market cash returns every quarter. Here is a brief overview of the four reasons why.
> REITs own real estate that has real value
No one ever loses money on long-lived real estate assets, and it’s reasonable to expect that appreciation to continue, as it has through multiple economic cycles.
At the same time, it’s not a straight or even line, and some areas, of course, are hotter than others at any given time. Case in point: industrial assets, especially logistics and warehouses, have an unprecedented premium.
For example, our largest industrial REIT, Axis-REIT, has reported that rents and property values continue to rise and they have limited vacancies.
The industrial space is now effectively sold.
> The stability of leases and the rise in rents
REIT managers lock in their rental returns through long-term leases, which guarantee REIT investors a steady stream of income used to pay dividends.
It’s “stable”, not “static”. Leases typically include rent increases, which can help mitigate the effects of inflation over the several years that a property is committed to the lease.
Of course, lease lengths vary widely and each REIT’s portfolio has a mix of expiration dates, so watch for those escalations to be even higher in the hottest sectors, as contracts expire against a rising price backdrop. inflation.
And if M-REIT managers can keep operating expenses flat against inflation while increasing rent, it can help maintain or increase their funds from operations, a key metric that is closely monitored by investors as an indicator of a REIT’s profitability.
> Interest Rates and REIT History
Bank Negara has just raised the Overnight Policy Rate (OPR) to 1.75%, but if inflation cannot be contained, we can expect another rate hike in the fourth quarter of 2022.
We forget, however, that from 2016 to 2020, the average RPO rate was 3% to 3.2% and all M-RETs performed exceptionally well in this interest rate environment.
The problem is that we have all become accustomed to this current low interest rate regime and some companies have overbalanced their balance sheets as a result. However, M-REITs have always kept their leverage low and in many cases have locked up their borrowing in long bonds with low fixed coupons.
The US-based National Association of Real Estate Investment Trusts has the longest period of performance data on REITs, and this data shows that while REITs have somewhat underperformed the S&P 500 in New York for during periods of low inflation, they have outperformed this benchmark index during periods of moderate or high inflation.
> REITs offer liquidity and agility unlike real estate assets.
No two real estate sectors are the same, and each publicly traded M-REIT has its own mix of property types, lease terms, geographic diversity and market conditions.
But they all share the liquidity that allows investors to buy and sell as they see fit in response to inflation and whatever this pandemic-ridden economy presents as a challenge is ultimately a buying opportunity.
M-REITs have been forecasting this recovery for the past 24 months, but at the same time have continued to provide their investors with strong cash dividends every year.
They have spent the past two years cutting costs, optimizing operations and refurbishing assets to take advantage of the return to normal markets.
Their unit prices are currently below their highs, but when things return to normal, their dividend performance will surprise the markets and we will see a sharp rise in their share price.
Datuk Stewart LaBrooy is Secretary of MRMA and President of Alpha REIT Managers Sdn Bhd. The opinions expressed here are those of the author.