Is Interest Rate Cut Positive to REITs?

Bank Negara Malaysia cut Overnight Policy Rate (OPR) by 25 basis points (0.25%) from 3.25% to 3.00% on 13 July 2016.

I could recall selected REITs’ prices moved up significantly after the OPR cut was being announced. 

To illustrate the above, IGB REIT was trading at RM1.61 per share on 1 July 2016 and the price rose to RM1.69 following the rate cut, this translate into 5% capital gain in less than 2 weeks’ time.

IGB REIT settled lower at RM1.58 as of 30 November 2016. The excitement and increase in the share price following rate cut seems to be short-lived.

So, is interest rate cut positive to REITs at the end of the day?

The following are some theoretical permutations and they are not meant to be exhaustive and the points below can also be discussed from various perspective.

Interest rate direction	Impact on share price	Impact on dividend
Decline	Likely to increase in short term	Inconclusive due to various moving factors to be elaborated below.
Increase	Likely to decrease in short term

Why would REITs’ prices increase when interest rate is being cut?

1)     Cost of borrowing becomes cheaper, but if the REIT’s borrowings are majority in fixed rate as opposed to floating rate, it may not benefit the REIT immediately in terms of lower borrowing cost. But there is feel good factor due to cheaper interest rate environment.

2)  Lower cost of borrowing may allow the REIT to incur more debts to acquire other income producing properties to be injected into the REIT.

3)  Fixed Deposit (FD) rate would also be revised lower, lower FD rate could increase the attractiveness of yield instrument such as REIT.

4)  In the short term, share price can fluctuate widely. But, share price should reflect the fundamentals of the REITs in the long run. If there is interest rate cut and the REIT’s fundamentals are poor, I doubt it will create much shareholder value in the long term.

Is cut in interest rate positive to REIT’s dividend payout?

1)      If borrowing cost becomes cheaper and the REIT has a lot of floating rate loans, there could be some interest savings which could be passed through to unit holders in terms of higher dividends. BUT….

2)   Why would Bank Negara cut rate at the first place? It is usually to support and stimulate the economy during weak economic growth environment. If Malaysia’s economy slow down further coupled with decline in consumer spending, this would affect retails sales and profitability of tenants, which in turn may impact their ability to even pay rental, hence impacting the REIT’s dividend payout in the extreme case. Currently, if a retail REIT could secure mid-single digit rental revision rate, a REIT's shareholders should feel happy.

3)    Hence, If the interest rate is being cut aggressively to stimulate economic growth, although REIT prices may increase in short term, if the tenants go out of business or unable to absorb higher rental payment if economy continues to be weak, the rate cut is unlikely to boost the REIT’s rental income significantly.

4)      Hence, if you invest in retail REIT, do continue to monitor the performance of its properties.

So far, Aeon Jusco, the Store and Parkson have not been doing well in terms of its retailing division; hence it will be important to monitor our retail REITs.

Is rate cut a definite positive to REIT? It depends J

Happy reading!