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Why share price correct down on REITs and Trusts on interest rate rises

The climb is fast but the drawdown is also fast for the low growth high dividend payers.

I am not sure how many were trapped inside, but mosi at mosi.sg came up with an article to say there may be a CAP on how high these will go or even more distressing downside.

I am rather lazy to explain so I came up with this.

 

 

You can read more in a previous article How Will Rising Interest Rates Could Dampen Investment in REITs

This segment is good when costs are low but if costs normalized, you wonder how they are possibly going to climb with rentals already that high.

The actual FED action may be at least a year away that’s my feel.

Your black swan is when even the FED couldn’t keep the rates down even if they want to.

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Kyith

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Anonymous

Saturday 15th of June 2013

In your notes, you mention that banks require convenants such as debt to current assets must be <X%. To my understanding, investment properties are classfied as non-current assets. So the revaluation of the properties may not necessarily affect these convenants right?

Any even if they do fail to meet their covenants, banks generally do not immediately recall the loan. As part of their KYC and annual credit review, they would have to understand the current economic conditions and apply them to the borrower. So they may impose other convenants in place depending on the situation at hand. I've seen this happen (although not specifically to REITS).

And assuming the rents are locked in and occupancy at 100% for a good number of years, what is the reason for the valuations of the properties to fall, especially if the implications of interest rates rising are generally in line with the economy improving?

Some reits do hedge their interest rate risk with IRS, so any unforeseen near term interest rate increases should be dealt with (at least until the next round of refinancing). Any CFO worth his salt would have a plan for the day interest rate rises, because we all know this isn't going to last forever. So fundametals of the company, management competency are equally important aspects as well.

Anonymous

Saturday 15th of June 2013

Sorry about the above. I meant to say this: In your notes you mentioned that banks require convenants such as debt to current assets must be below x% but to my understanding, investment properties are considered non current assets, so how does this affect the convenant? Even if they fail to meet the convenant, banks need to do their KYC and annual credit review by understanding the current economic situation and how the borrower is affected. So a simple breach of the convenant alone would not mean a recall of the loan or immediately imposing higher borrowing costs. Unless there is reason to believe that the valuation of the mortgaged properties have declined so much, the bank could instead impose a different set of convenants that better match the current economic situation. I've seen this before (but not specifically to REITS). Lastly, some reits hedge their interest rate risk using IRS. So any unforeseen near term increase in interest rates would not affect them too badly. Ultimately any CFO worth his salt would be well prepared to deal with increases in interest rates as everyone knows this is not going to last forever. So we have to also remember that other than good fundamentals, competent management is also very important.

Jackson

Friday 14th of June 2013

Hi Drizzit,

An increase in interest rates will also have an effect of the capitalization rates of the properties held by the REITs. This cause the book value of the property to fall and this will show us negative earnings during the annual valuation. Although this has no impact DPU wise it is another negative implication of an increase in interest rates.

On a side note, I find that people are trying to make too much sense of this correction and it is a simple change of sentiment that has caused the market to turn so quickly. Fundamentals have not changed one bit. Given that this fall is likely to me quite minor (<20%) perhaps when people look back it will be a good lesson to them.

Kyith

Friday 14th of June 2013

the change in mood is really crazy isn't it. but the fear is that the rates would not be kept down forcefully. i think i cite that in my image where the book value and price is effective 1:1. and thus the book value gets affected.

but yes i think your explanation is better on revaluing it down through losses.

i was actually being labelled as a trolled in hardwarezone

Snoopy168

Thursday 13th of June 2013

Perhaps it is possible that the REIT increases their rent over time, to combat rising interest on the borrowing cost & overheads.

Within limited space Singapore, there isn't much other choices of cheaper rent. I heard that JTC flatted factory / HDB shop houses rental also going up & up. Exception of moving overseas, there isn't much choices.

Kyith

Thursday 13th of June 2013

Hey snoopy hence the bottom illustrations. I am not sure if it needs to be over a period of time. I think it is near term demand

There are companies moving over but another aspect is maximizing plot ratio through redevelopment

Andy

Thursday 13th of June 2013

Hi Drizzt.. Juz wonder at this point of time what can trigger interest rate to go up & who (which country) will be willing to do it?

Cheers Andy

Kyith

Thursday 13th of June 2013

Hi Andy, I think the time for that may be away. If inflation starts creeping in there will country taking that stance

We are afraid of a 1977 bond vigilante situation where they say enough is enough a s force up yields

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