Rising bond yields are a global phenomenon, and REITs’ unit prices may be pressured by this trend. Currency risk management and capital management are the two variables that REIT managers can use to mitigate the impact of rising rates on distributions.
Daiwa House Logistics Trust’s (DHLT) unit price has been on a steady decline, and is now trading well below its IPO price of 80 cents, despite a sound capital management strategy. This decline has taken place since early May, when the US Federal Reserve made known its intention to raise the US Federal Funds Rate further and faster than at any time in the past 10 years. In addition, the Fed has announced a quantitative tightening programme.
At the same time, the Bank of Japan has not moved on Japanese rates, nor has it stopped its quantitative easing programme causing the Yen to weaken against the Singapore dollar. On the other hand, yields on 10-year Japanese Government Bonds (JGB) have risen from around 0.069% at the start of the year to 0.23%, a significant gain, albeit from a very, very low level to a very low level.
Elsewhere, Digital Core REIT, which had rallied as high as US$1.20 post-IPO, is now barely holding above its IPO price of 88 US cents.
In its 1Q2022 business updates, DHLT’s manager announced that its net asset value (NAV) had fallen from 92 cents as at Dec 31, 2022 to 86 cents as at Mar 31 because of the depreciating yen against the Singapore dollar.
In its prospectus, Daiwa House Logistics Trust’s manager said its policy is to hedge DHLT’s anticipated foreign currency exposure in respect of distribution income from its overseas assets on a rolling one-year forward by using foreign currency forward exchange contracts and other foreign currency derivative instruments. Since Japanese rates are lower than Singapore rates, these forex hedges could be profitable in DHLT’s financial statement.
On the other hand, DHLT’s manager is likely to use natural hedges for the properties - that is - it is likely to match the yen assets with yen debt, and this has pressured NAV. Of note is that 100% of DHLT’s debt is on fixed rates, and its debt expiries are staggered which are a reflection of sound capital management.
Despite US dollar strength, Digital Core REIT’s unit price has also retreated. This is because the REIT manager started the year without any fixed rate debt. Moreover, all the debt taken on at IPO is not staggered, and expires at the same time.
Digital Core REIT’s manager announced on April 21 that it had established a minimum target of 50% fixed rate debt and entered into a US$175 million interest rate swap to mitigate interest rate risk. The REIT has some US$500 million of debt, of which US$350 million has been drawn down, and the remaining US$200 million is undrawn. The amount that is on fixed rates is just US$175 million. Cost of debt is 2.1%.
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The cost of debt includes the pro forma cost for US$175 million interest rate swap, assuming the swap was outstanding for the entire 1Q2022 period. Actual average cost of debt for the 1Q2022 period was 1.2%, the manager says. This implies that cost of debt in 2Q2022 is likely to be a lot higher, as cost of debt is likely to rise from hereon.
At IPO, Digital Core REIT’s manager promoted its US$15 billion pipeline as a growth story. As interest rates and risk-free rates rise, unit prices may be under pressure, making growth by acquisitions a lot more challenging than when the IPO was launched in Dec 2021.