REIT vs Interest Rates - Volume 2

I've received mixed responses further to my prior post regarding interest rates and REITs and decided to blog part two to it. I mean, a sequel is always fun right?

What affects the price of a REIT?
There are numerous factors affecting the price of any equity, including REITs. However, the two primary reason for any adjustments in the price of a REIT is:

Revenue (mainly rental income)
Expenses (mainly interest expense)

Interest expense
The traditional notion and theory behind interest rates and REIT's price is an inverse relationship. I mean, its simple right?

" Higher interest rates = higher interest expenses for REIT = lower DPU as most REITs are highly geared. "

Well then, let's look at a chart from investopedia.

Oh wow! Looks like there's really an inverse relationship as a result of a knee-jerk reaction. Investors who applies the above "formula" will quickly sell off their REITs when interest rates rises.

Look closely again, realise that the performance of the REIT somewhat "lags" behind the effects of treasury yield? That's because we should always remember why do interest rates rise and fall.

What affects interest rates (at least in U.S)?
Supply & Demand
Higher economic activities and business growth/expansions tend to lead to higher demand for borrowing. This leads to higher interest rates, ceteris paribus.

Inflation
Higher inflation likely leads to higher interest rates as lenders seek to compensate for the reduction in purchasing power when their money is repaid in the future

Government/ Federal Reserve (Fed)
Fed lowers or hike interest rates when the economy needs a boost or cooling down respectively.
When the Fed raises rates later this year, it is because economic data continues to improve and that rates should finally normalise after being kept artificially low for long period of time.

Revenue/Rental income
The traditional notion above, tends to forget that there are many moving parts to this equation. Interest expenses can increase and decrease. So can Revenue.

When the economy continues to grow, there will be higher demand for leases.

Starting in June of 2004 and ending in August 2006, short-term rates were hiked 17 times from a starting point of 1.00 percent to a peak of 5.25 percent. Over this two-plus year period, GDP grew steadily and commercial property values increased. Importantly, REIT investors were rewarded with more than a 60 percent return over this time frame, beating the overall stock market’s 20 percent rise. When including the past 6 tightening cycles going back to 1977, research has shown that REIT stocks appreciated in all but one. (source:forbes)

With rising GDP growth and economic activities, REITs can demand higher rental revisions to boost their top-line.

Do not forget the underlying business you're investing in
REITs with good management can display this. Capitaland Mall Trust, is one such example:

Source: http://www.fool.sg/2014/10/23/can-capitamall-trust-continue-to-grow/

CMT has an excellent track-record in increasing its revenue and distributable income, even during times of recession and rates hike. This proves that a superb management can ride the storm and even beat the market.

What about Singapore?
All that have been said is mostly reference to U.S, what about Singapore?

Singapore's economy is largely dependent on the major economies like U.S & China. Continued growth in those countries will have positive impact to Singapore.

Interest rates in Singapore
SIBOR is affected by two main factors: Oversea's interest rates and strength of SGD against other currencies.

MAS does not directly dictate our SIBOR rates (some say we say interest rate takers). However, MAS manages SIBOR indirectly by adjusting the strength of SGD against a basket of currencies. This is MAS's method of managing Singapore's economy is it is very unique.

The other variables
I started the post mentioning that there are numerous factors affecting the price of REITs. One other important factor is the industry. Some industries are more resilient while others are more cyclical. Investors should also take into account such factors when making decisions.

Rights issue
AK written an excellent post about REITs and Rights issue here. I think I couldn't put it more clearly than he did.

Its not all about the price
All that have been said relates to the price of REIT. But really, should long-term investors be bothered by the prices of the ticker? In the short-term, the price of a stock may not reflect the true value of the business.

I like to believe in investing good businesses for a long period. A look at CMT's share price since IPO (2002) shows a tremendous increase from $0.96 to $2.22. This includes rights issue but excludes dividend distributed. Past performances doesn't guarantee future growth. But I know as long as the management maintains the good work done, I'll have little worries over my purchases.

We should always remember that there are many types of REITs in the market. Pick wisely, and you can sleep soundly :D