[Rate Cuts] Is It A Good Time To Invest In REITs?

Over the past few weeks, I’ve been seeing a lot more content revolving around the expectation of a price recovery in REITs driven by the rate cuts that are happening in the second half of 2024.

While it is an open secret that central banks are starting to cut their interest rates (starting with the European Central Bank in June 2024), the impact of the rate cuts might not affect the fundamentals of the REITs anytime soon and neither will it affect the REITs equally due to the following three reasons.

1. Already Refinanced High

Unfortunately, most of the REITs have already refinanced their existing debt between 2023 and 2024 which has caused the weighted average cost of borrowing to go up significantly over the last two years.

We’ve seen the impacts of that in the form of a worsening distribution across almost every REIT that was listed in the Singapore Exchange with higher borrowing costs being sighted as the main reason for the decline in distribution.

As the weighted average debt maturity of most REITs usually hovers around 2 to 3 years, there will likely be a delay of a few years before the positive impacts of rate cuts can be felt in the bottom line of the REIT's performances as they are unable to immediately refinance to a debt with a lower interest rate.

2. Rate Cuts Takes Time

That said, even if interest rates were to be cut starting from the latter half of the year, it would still take the central bank another 12 to 24 months to slowly taper their interest rates back to the neutral interest rates level. (Estimated to be at around 2.5% to 3%)

As such, any REITs with refinancing requirements between 2024 to 2025 will likely have to suffer the impact of the current high-interest rate environment as they are forced to refinance at a higher level thereby causing the cost of debt to remain high for a longer period.

Based on my understanding of the REITs that are listed in Singapore, my base case expectation for the cost of borrowing for most REITs is that it will maintain at its current levels for the next 12 to 24 months before slowly coming back down.

The situation may be made worse if an REIT has concentrated refinancing requirements between 2024 and 2025 as they might be forced to lock in their cost of borrowing at a higher rate for another 2 to 3 years.

3. Not All Central Bank Is Cutting Rates

What a lot of investors tend to forget is that the topic of rate cuts is usually only spoken about in the Western developed markets - mainly Europe and the United States. While their actions do play a role in the decisions of other central banks, it is important to note that not all central banks are moving in the same direction.

For instance, the Central Bank of Japan is still on the path of tightening its interest rates while the Central Bank of China is likely going to leave their key policy rates unchanged having lowered them steadily over the years to support their economy.

What this means is that investors should pay closer attention to the domicile of the properties that the REIT invests in and not expect the narrative of a rate cut to lift all boats in Singapore’s REIT market.

This is especially true as a good majority of the REITs listed in the Singapore Exchange have heavy exposure to countries like China and Japan and we’ve also seen a lot of Japanese property acquisitions done in the last two years as REITs seek to take advantage of the lower interest environment in Japan when other developed countries are hiking their rates.

TLDR:

While it is a fact that interest rates will come down in the future and that a lower interest rate environment will benefit the performance of the REITs, it is unlikely that the impact will be felt immediately like what most investors are hoping to see.

As such, I think investors who are looking to deploy their funds into REITs should perhaps be more patient and set multiple price targets to slowly enter the market instead of trying to jump onto the bandwagon of the narrative of rate cuts.

While I do not have a crystal ball about the future, what is true in the past is that the market tends to perform poorly when the fundamentals underperform investors' expectations and right now, I feel that investors are somewhat a bit too hopeful about the immediate impact of rate cuts which may position them for disappointment.

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In 2024, I'll be covering all the REITs that are listed in the Singapore Stock Exchange and sharing my views and opinions on it in the form of analyst reports that can be downloaded on my telegram channel.