It has been a while now since I last posted an article update on S-Reits. The last time I did that was back in Aug last year and it has been slightly more than 6 months since. For those who are interested in my previous update, you can refer to the article here.
The news surrounding the impending increase in interest rates is gaining momentum now and I think as a vested investor in S-Reits, we need to understand the consequences of an increase in interest rates which will affect the company’s cost of doing business and their bottomline, which in turn will affect the distribution income paid to shareholders as dividends.
I've actually turned bearish on S-Reits stocks since the start of the year. With valuations to their compressing yield spread and book value rather high, plus the impending increase in their respective cost of debts, I doubt they will be able to sustain their relative high valuations for very long much longer. Any investors that tried to enter the S-Reits market at the current price need to fully understand the impact and consequences that will unfold within the next few months. The thing about investing in S-Reits is most investors like the feeling of getting a quarterly income through the dividends from the rental properties and this gets repeated over and over again if they have build up a sustainable portfolio of S-Reits. However, I realized that in the pursuit of income investing, most investors failed to look beyond their second level of reasoning which is all the more important.
The first thing is Timing. Investing in S-Reits at the depth of when Quantitative Easing was just started is different from the timing of when Quantitative Easing was about to end. As I will mention more in detail later below, the impact on the cost of debt is something that an investor needs to consider rather than assuming that dividend distribution can only move upwards all the time.
The second thing is Valuations. Many investors attribute valuations to property counters by looking at their book value. Again, a quick look across the board and we can see that many of the S-Reits counters now are trading near or over their book value. In other words, you are paying the full value of what their properties are being valued right now, subject to revaluation on a yearly basis. That is hardly anything a value investor will be doing right now. Contrast this to a few property developers which are trading at half the book value and you roughly get the idea.
The third thing is Distribution Payout. By now, everyone should know that S-Reits stocks are structured in such a way that they will have to distribute out more than 90% of earnings to enjoy tax benefits. Some S-Reits even pays out the full 100% distribution of their earnings. This means that the companies are retaining very little to grow their business through inorganic merger and acquisitions or Asset Enhancement Activities. Organic growth through rental step-up will also have to be contained one day, as the increase will not be forever. Worst, it might even goes down during an economic crisis.
Anyway, back to our main discussion for this post, I shall divide it into two separate parts for our easy reference. The first part will be focusing more on the latest update of the various Reits debt profile expiry while in the second part we will see how sensitivity analysis will help us to determine the impact to the increase in their cost of debt percentage.
Debt Expiry Profile
Many investors would have known by now that S-Reits companies thrive on leverage during the low interest rate environment that push their costs of financing low. As a result, many companies are gearing up for more organic and inorganic growth through AEI and acquisition respectively during these few years.
If you have taken a closer look at their financing terms, you would have noticed that a lot of the loans these companies were getting is on a typical 3-year loans. When the term is up, they would have to engage in further financing possibly at a higher rate. Many companies such as the Mapletree Reits Group have also tapped on their capability to issue a Medium Term Note (MTN), which is typically of longer duration and more flexibility. Many companies have also locked in a fixed rate on their debt to keep their financing not being subject to the volatility of floating interest rate.
The truth about the debt expiry profile is we will see a cycle of S-Reits companies refinancing their loans at a higher interest rate now than before. It is not something that is necessarily bad, but is something that everyone and the management would have known that it is going to happen, and it is up to us how we want to see them.
|Debt Expiry Profile|
Sensitivity Risk Profile
The second part is the continuation on the first part where I have done a table based on the sensitivity risk profile to increase in interest rate of 0.5% in 2015 and 1% for subsequent year (cumulative interest 1.5%).
The sensitivity analysis is taking into account the respective Reits' profile on the debt expiry, fixed loans rate and current cost of debt rate when computing. Based on the table below, MAGIC and Ascott would be the worst to be hit by the increase in interest rate in 2015 while CapCom, MAGIC, SPH Reit and FCT would be next to be hit in 2016.
Again, these does not mean anything but rather just a profile to see what is in it for them should interest is increased in the next few years.
While S-Reits do provide a stable and recurring income that makes an investor feeling good, as an investor we certainly do not want to overpay for what their worth are. The key is to keep looking, assessing their risk and wait for a better opportunity to enter if valuations are rather stretched. Weigh the pro and cons and come up with your risk adjusted return conclusion. Who knows, you might just get a better deal.