Singapore’s Market for the Week: REITs Nosedive

One of the big stories for the week was the 7% plunge in Japan’s Nikkei 225 Index on Thursday. That came after reports of weak manufacturing activity in China surfaced together with news of a rise in interest rates in Japan, sparking fears of a halt in Japan’s attempted economic recovery under Abenomics.

In Singapore, the Straits Times Index (SGX: ^STI) was down for the week by 1.6% to 3,393 from last Friday’s close of 3,449. The index had more-or-less stayed flat from Monday to Wednesday before Thursday’s 1.8% plunge to 3,393, possibly due to contagion with the Nikkei’s fall.

For investors who are focused on Singapore’s blue chips, they might have missed an interesting development in locally-listed Real Estate Investment Trust (REITs) which might have been a result of the rise in interest rates in Japan – none of the 23 REITs listed on the Mainboard stock exchange ended with gains on Thursday.

The losses ranged from the 2.1% decline to $0.192 for the Japanese real estate-related Saizen REIT (SGX: DZ8U), to the 6% drop to $1.49 that commercial property REIT Frasers Commercial Trust (SGX: KT8U) suffered. Even Singapore’s oldest REIT, CapitaMall Trust (SGX: C38U) wasn’t spared as the retail property REIT went down by 5.7% to $2.17.

In Japan, a big part of Abenomics involves the buying of bonds by the Japanese government, which was expected to continue to lower interest rates. But, interest rates started spiking in the midst of the bond-buying programme, putting questions into the efficacy of quantitative easing and if the prevalent low interest rate environment can continue. To see how this relates to REITs, we have to look at their capital structure.

REITs carry significant debt on their balance sheets and because of legal requirements for them to distribute almost all of their income, they only have three options to deal with debt: 1) Refinance due-debts with new debt, 2) Raise additional cash through an offering of units or 3) the worst-case option of having to sell-off income producing assets for cash to pay up for loans that are due.

If interest rates start rising across the board, REITs are going to find debt a lot more expensive to obtain during refinancing. With expensive debt come higher interest payments and if rental incomes are kept constant, unit-holders will find themselves with a much smaller income.

That’s not all. Both Option 2) and 3) will only cause existing unit holders to suffer, either through dilution (for the second option), or from the loss of partial rental-income (for the third option). It’s not a good position to be in for a REIT investor if they are caught between these insufferable situations.

No one can calculate with mathematical precision the odds of those adverse events I described earlier. But, those risks are present and some of them have been raised by ratings agency Fitch Ratings in March this year. With leverage, comes risk and so, investors ought to tread carefully.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.