REITs' virtuous and vicious cycles
REITs generally enjoy a virtuous cycle during good times.
When the economy is growing, REITs enjoy better occupancy and could increase rent without losing tenants. Therefore they are able to grow their rental income.
A higher income means REITs could distribute more dividends to unit holders and the underlying properties also appreciate in value.
A higher valuation lowers the gearing and allow the REITs to take on more mortgage loans.
It is also likely that the share prices are favorable (above book value) for the REITs to conduct rights issues.
The ability to borrow more (especially when interest rates are low too) and to raise funds from unit holders meant that the REITs could acquire more properties to expand their portfolios.
All these positive signs (higher distributions, higher valuations and portfolio growth) propel the REIT prices upwards.
But what can help them can also harm them.
That is when the vicious cycle starts to take charge.
During an economic slowdown, demand for real estate goes down. This leads to lower occupancy and rental income for the REITs.
In turn, dividends might get cut and the REIT prices are likely to fall.
It is worse when interest rates are rising too - the financing charges go up and dividends are reduced further.
With lower projected rental income, the property values are likely to come down too.
This would cause the gearing ratio to go up and reduce the debt headroom.
REITs might even need to sell properties or carry out a rights issue to keep their gearing below the legal requirement.
But this would be a bad time to sell as demand for real estate and the valuations have fallen. REITs have to sell the properties for cheap.
Rights issue is not good either since the share prices have fallen. Less money can be raised and additional units are priced at a discount to the property valuations.
Hence, keeping to the required gearing can be a handful for some of the REITs, they have no capacity to explore expanding the property portfolio.
REITs are currently undergoing the vicious cycle and riskier REITs will find it more punishing to go through it. Higher quality REITs would also take a hit but will be less impactful to them.
The virtuous cycle will return one day. But we believe the higher quality REITs are the ones worth buying because they are likelier to emerge stronger from this cycle.
(High quality REITs can be gauged by consistent DPU growth even during bad times, well-known sponsors, good property portfolios and competent management.)
video to explain the vicious cycle: https://youtu.be/6VI3JBrzPBU
Disclaimer: Community is offered by Moomoo Technologies Inc. and is for educational purposes only.
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