Higher interest rate doesn't bode well for local REITs, except this one...

Raising interest rates will likely be the main monetary policy tool for many central banks over the next 6 - 12 months, as global inflation worsens. Locally, there could be one more OPR hike in the remainder of 2022 after the previous two rate hikes totaling +50bps bringing the OPR to the current level of 2.25%.

Fyi, the current mortgage rates are around 3.15%. Of course, a higher mortgage means higher financing costs for the REIT sector, which will lead to earnings being compressed. (Click here to read more about REIT-related articles)

The type of loan is the determining factor...

Yeah. There are two types of loans namely floating rate loans and fixed rate loans. So, amid the higher interest rate environment going forward, those REITs with a higher proportion of floating rate loans will be impacted the most.

Among the local REITs under the coverage of RHB Research show that the highest proportion of floating rate loans are Pavilion REIT and Sunway REIT, whereas IGBREIT's loans are almost all on fixed terms.

Source: RHB Research report dated 28 June 2022

Meaning, IGBREIT will be 'immune' from the impact of higher interest rates due to the hike in OPR.

However, this doesn't mean a gloomy outlook for the local REIT sector due to its stable dividend yield and healthy gearing ratio. Whether the dividend yield can be sustained or not, it very much depends on the occupancy rate and how well the REIT managers handle or renew the soon-to-expire tenancy agreements.

Catalysts for local retail REITs: 💫💫💫

• tapering of rental assistance to tenants
• lifting of various health restrictions
• reopening of international borders

This evidence was reflected in the latest quarterly earnings report shown by some local retail REITs, such as IGBREIT +88% yoy, CLMT +101% yoy, and PAVREIT +169% yoy.

Hong Leong Investment Bank (HLIB) Research on IGBREIT:

“The overall year-on-year improvement in 1H22 was mainly due to improving retail sales arising from better shopper footfall with the transition to endemicity. Both properties – the Midvalley Megamall and the Gardens Mall’s occupancy remained robust, at more than 99% while gearing stood at 23%." 💝💝💝

However, this is not the case for local office REITs (such as SENTRAL and KLCCP) due to the downward pressure on occupancy rates as a result of the growing mismatch in supply and demand for office space. More and more tenants are evaluating their working arrangements, downsizing their presence in offices by adopting a hybrid work model. 💥💥💥

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