3 Reasons Why REITs Will Continue to Do Well This Year

2021-01-12     thesmartinvestor
3 Reasons Why REITs Will Continue to Do Well This Year

The REIT sector did not have the best of years in 2020.

However, certain REITs managed to emerge relatively unscathed.

These REITs typically have a strong sponsor, along with tenants that are resilient and long leases that helped to buffer against income volatility.

There were even a handful of REITs, such as Ascendas REIT (SGX: A17U), that conducted accretive acquisitions in 2020 to boost their distribution per unit (DPU).

Income-seeking investors will take comfort in knowing that REITs can continue to do well this year, even as the world recovers from the debilitating pandemic.

Many of the stronger REITs are on the lookout for suitable acquisitions to further boost their portfolios and increase DPU for unitholders.

Here are three reasons why I believe these REITs can continue to do well this year.

Low interest rates

Because of the pandemic, countries around the world are lowering interest rates to stimulate their battered economies.

These low rates aim to stimulate businesses to borrow to expand and grow.

Another intended effect of these low rates is to make loans more affordable to service and to lower the overall finance cost for indebted firms.

REITs carry significant amounts of debt on their balance sheets and their property assets are pledged as collateral for loans.

With interest rates staying low, this means that REITs can also borrow at overall lower rates to fund acquisitions.

Some examples of REITs with low borrowing costs are Parkway Life REIT (SGX: C2PU) at 0.54% as of 30 September 2020, and Keppel DC REIT (SGX: AJBU) at 1.6% per annum.

And with borrowing costs being so low, the REITs just need to refinance their older debt at current rates to enjoy cost savings.

Presence of cheap assets

With most of the world still under pressure from lockdowns and movement control restrictions, real estate assets in certain regions may see their values falling.

Lower demand for office space and tenants’ financial stress results in falling rental rates, leading to bargains emerging for quality assets.

Moreover, landlords may also be facing financial pressures as cash flow dries up and construction and development of real estate assets take a pause due to the crisis.

To raise cash, some of these landlords and property companies may be pressured to sell off assets on the cheap to raise cash urgently.

REITs that have the financial muscle to borrow can then swoop in on these distressed assets to add to their portfolios.

Note that because of the outbreak of the pandemic, Singapore’s central bank has raised the gearing limit for REITs to a maximum of 50%, up from 45%.

This move provides REITs with more leeway to gear up to finance their acquisitions and will act as a further catalyst for growth.

REITs trading at low yields

Acquisitions are made easier when REITs are trading at low dividend yields.

Let me explain.

If a REIT is trading at a 3% yield and makes an acquisition that yields a net property income (NPI) yield of 5%, this means the acquisition will be positive for the REIT’s DPU.

In a nutshell, the REIT could issue new shares at this 3% yield to acquire an asset that generates a 5% NPI yield, thus “earning” the difference of 2%.

Interestingly, REITs that have strong sponsors and are resilient tend to trade at lower dividend yields.

For instance, Mapletree Industrial Trust (SGX: ME8U) trades at around a 3.6% dividend yield while Keppel DC REIT’s dividend yield stands at about 2.7%.

With dividend yields well below 4%, these REITs simply need to find assets that provide a higher than 4% NPI yield for the transaction to be DPU-accretive.

Get Smart: Expect a sustained recovery

Notwithstanding the above, the REIT sector is expected to see a gradual recovery this year.

Although many countries continue to grapple with the virus’ resurgence along with new strains, it’s a matter of time before the disease is conquered through vaccinations.

The worst of the crisis is behind us and REITs that have done well should continue to find opportunities for both organic and acquisitive growth.

REIT investors should continue to enjoy stable distributions while awaiting for a DPU uplift from acquisitions.

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Disclaimer: Royston Yang owns shares in Keppel DC REIT.

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