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Hey fellow REIT investors! If you’ve been following the markets, you might have noticed something strange happening. Interest rates, specifically, the U.S. 10-year Treasury yield, have been quietly trending lower over the past month. Now, if you’ve been reading my posts, you’ll know that I’ve called this my “Fear Index” for REITs. When rates were rising, I warned that REITs would struggle because higher interest costs eat into their earnings and generally investors have more attractive alternatives to invest in. But now that rates have started to decline, REITs should be bouncing back, right?

Well, here’s the reality before our eyes: REITs haven’t really moved in the past month. In fact, they have even dropped slightly. What’s going on? If even lower interest rates are not considered good news for REITs, then won’t we, long-term REIT investors, be in trouble? In today’s post, let’s break it all down.

First, we’ll explore why interest rates have been falling, and what’s really driving this trend. Then, we’ll discuss why REITs haven’t reacted. Then, I’ll highlight two REITs that could benefit first if rates continue to decline, but is this the panacea we’re looking for? And, as always, stay till the end for “The Dividend Uncle’s Take”, where we’ll talk about whether this signals better times ahead for REIT investors!

Before we dive in, let me remind you that this post is for informational purposes only and not financial advice. Always consult a licensed financial adviser to ensure your decisions align with your goals. And yes, I hold the REITs discussed in my portfolio, but remember, what works for me might not work for you.

Alright, let’s get started!

Why Have US 10-Year Treasury Yields Declined?

So, why exactly have interest rates been falling over the past few weeks? Surprise! It’s not just about the Federal Reserve or inflation anymore: there are multiple factors at play. 

Grab a cup of Kopi Gao, and let’s break them down.

1. Weakening Economic Indicators

The US economy has been showing signs of slowing down, and investors are starting to take notice. In January, consumer spending contracted by 0.2%, the first decline since March 2023. Now, that might not sound like much, but when consumer spending slows, it raises concerns about overall economic growth, since consumer activity makes up about two-thirds of the US economy.

2. Policy Implications on Economy Going Forward

Looking forward, the US economy is facing new challenges. With fresh tariffs on imports from Canada, Mexico, and China coming on and off and on again, businesses are worried about supply chain disruptions and rising costs. If companies start cutting back on production or delaying investments, that could further weigh on economic growth.

In addition, these policy uncertainties, including trade tensions, are concerning for businesses and investors alike. 

3. Investor Flight to Safety

In addition, markets hate uncertainty, and the policy uncertainties will lead investors to reposition their portfolios. Where do investors run to? Safe-haven assets like US Treasury bonds. Over the past month, we’ve seen increased demand for Treasuries as investors worry about slowing growth and potential market volatility. And when demand for bonds goes up, bond prices rise, causing yields to fall.

4. The Federal Reserve’s Cautious Stance

Now, let’s get back to talking about the Fed. Everyone’s been waiting for the central bank to cut rates, but it seems like they’ll be holding back for a while. In January, the Fed kept rates steady, emphasizing that they need to see more evidence of inflation cooling before making any moves.

Translation to what this means? Well, the Fed doesn’t want to cut rates too soon and risk inflation making a comeback, especially given uncertainties around fiscal measures. But at the same time, if economic data continues to weaken, they might have to step in and lower rates to support growth. The bond market is already trying to anticipate this, which is why yields have been falling.

Why REITs Haven’t Reacted (Yet)

Alright, moving past the more technical parts of the post, we’ve established that US interest rates have started falling. Naturally, you’d expect REITs to bounce back, right? After all, lower interest rates mean lower borrowing costs and a higher potential for yield-seeking investors to rotate back into REITs. But if you’ve been watching the REIT market closely, you’ll know that prices haven’t moved much. In fact, some REITs have dipped over the past month: this includes Mapletree Industrial Trust, and Frasers Logistics and Commercial Trust.

It’s frustrating, I know. You’re probably wondering, “Why isn’t the market responding? Have investors forgotten how REITs work?” But actually, there are some very real reasons why we’re not seeing an immediate reaction. 

1. It Takes Time for Interest Rate Cuts to Flow Through

Imagine you have a mortgage. If interest rates suddenly drop, does your monthly mortgage payment go down immediately? Nope. You’re likely locked into a fixed rate, and unless you refinance, your loan terms don’t change overnight.

The same applies to REITs. Most REITs hedge their debt by fixing interest rates for a certain period. This means even if borrowing costs decline, they won’t immediately feel the benefit. Those lower rates will only kick in when existing loans are refinanced. This means that the dividends from REITs will continue to be under pressure for a while.

So, just because interest rates have started trending down doesn’t mean REITs will instantly see cost savings. The impact is lagged, and it could take a few quarters before lower borrowing costs start meaningfully improving their financials. Investors know this, and that’s why they aren’t rushing in just yet.

2. Market Sentiment on REITs is Still Cautious

We’ve all been burnt by REITs before – the false dawns have left a scar. Last year, when the market thought the Fed was going to cut rates aggressively, REITs rallied, only for that optimism to be crushed when rates spiked again. Investors are still cautious, waiting for more confirmation that this downtrend in interest rates is sustained before committing more money to REITs.

On top of that, many investors are still nursing their wounds from the brutal REIT sell-off over the past two years. They will need stronger signals before regaining confidence.

3. The Stock Market is Struggling, And It’s Dragging Everything Down

Here’s probably the most impactful factor in the short term: overall stock market performance. While lower interest rates should be a tailwind, broader market sentiment plays a huge role in short-term price movements. And right now, the market isn’t in the mood to celebrate.

Over the past month, global stock markets have taken a hit, with the US being the worst performer. The tech-heavy Nasdaq has dropped nearly 10%, almost hitting the threshold for a technical correction, a sharp reminder that even the strongest rally can stumble. This “risk-off” sentiment has sent shockwaves through global markets, and Singapore stocks, including REITs, haven’t been spared.

When the market is falling, investors tend to pull back from all asset classes, even those that logically should benefit from lower interest rates. Right now, the focus isn’t on stable dividends or long-term recovery plays, it’s on avoiding losses. Until the broader market finds stability, we might not see REITs getting the attention they deserve.

Why are REITS always on the losing end?

I know what you’re thinking: “How come when the US market drops, REITs drop… but when the US market goes up, REITs also drop?” It feels like no matter what happens, REITs just can’t catch a break! This is a conversation I have with my friends over many kopis, but it’s not actually as straightforward as it seems.

The key difference is in what’s driving the US market at any given time. When US stocks are surging in the past 2 years, it’s often because investors are chasing high-growth sectors like tech, which pulls money away from slower-growing, income-generating assets like REITs. On the flip side, when the US market is falling right now, sentiment across global markets turns negative, and investors shift into a “risk-off” mode, causing everything, including REITs, to decline.

So, while it might seem like REITs are always on the losing end, the reality is that their long term performance is tied more to interest rates and economic performance driving demand for their underlying properties, rather than just US stock market or investor sentiment. 

Before we move on to the two REITs that may benefit first from sustained interest rate declines, and if you’ve enjoyed our chat so far, please hit the ‘like’ button and subscribe to the channel! This will give me motivation to continue bringing your up-to-date content. Really appreciate your support!   

Which REITs Could Benefit First?

Alright, so we know that lower interest rates should eventually help REITs, but which ones could benefit the most? If rates are trending down, it makes sense that the biggest winners would be those REITs that have been hit hardest by rising borrowing costs. And that means looking at REITs with a higher proportion of floating-rate debt, because they’ve been absorbing the most pain from rate hikes, and now they could be the first to see relief.

Interestingly, two hospitality REITs stand out. These two REITs have among the lowest proportions of fixed-rate debt among all Singapore-listed REITs. That means their interest expenses have been rising fast, but on the flip side, they are also in a position to see immediate savings when rates decline. Let’s take a closer look.

CDL Hospitality Trust – Feeling the Squeeze but Ready for Relief?

CDL Hospitality Trust has 67.9% of its debt on floating rates, which means it has been directly impacted by rising interest costs. And the effects have been clear, just take a look at its latest financial results.

Interest expense has surged, dragging down distributions. The higher borrowing costs contributed to an 11.9% drop in distribution per unit in 2H 2024, falling from 3.19 cents to 2.81 cents. That’s a painful hit for dividend investors.

Why this matters now: With rates trending down, CDL Hospitality Trust’s interest expense should start easing, giving its distributions some breathing room. If we get sustained rate declines, the distribution per unit could start recovering, making this REIT one of the earliest beneficiaries. In fact, management is optimistic that their interest expenses are likely to fall going forward, especially with more substantial interest rate cuts in Europe.  

Far East Hospitality Trust – The Biggest Swing Factor?

Far East Hospitality Trust is in a very similar position, with 42.1% of its borrowings unhedged. Like CDL Hospitality Trust, this means its interest costs have been climbing sharply in the past year.

Higher rates have weighed on earnings. In Financial Year 2024, Far East Hospitality Trust’s distributable income dropped 11.3% compared to the previous year. One key reason? Rising interest expenses, which have been eating into its bottom line. It is only with a distribution of $8 million from gains arising from the divestment of Central Square, that the distribution per unit managed to decline by a much smaller 1.2%.

Why this matters now: With a high proportion of floating-rate debt, Far East Hospitality Trust’s financing costs could come down relatively quickly as rates decline. This could help strengthen its distributable income and make it more attractive to investors looking for a turnaround play in the REIT space.

The key takeaway is our discussion here: these two REITs have been among the hardest hit by rising interest rates, but they are also in a position to be among the first to benefit as rates decline. The question now is, will rates continue trending down long enough for them to capitalize on this advantage?

The Dividend Uncle’s Take: What This Means for REIT Investors

So, what’s my take on all this?

First, it’s clear that falling interest rates are a positive development for REITs. But investors need to be patient because the effects take time to show up. This has just been one month of decline – a single month does not make a trend.

As I mentioned earlier, I like to think of the US 10-year Treasury yield as my “fear index” for REITs. When rates are high, fear is high, because higher borrowing costs hurt REITs. Now that rates have dropped slightly, we can say that the fear level has come down. But let’s be clear, it’s not gone yet. Investors are still wary, and they want to see a sustained period of declines before they’re convinced that REITs are truly on the path to recovery.

Second, while most REITs have been slow to react, sentiment can shift before fundamentals do. If US 10-year yields continue to decline, and the global stock market regains some stability, we could see investors gradually returning to REITs, even before interest cost savings fully kick in.

Third, I want to share my views that REIT managers are not in the business of predicting interest rates. Some investors might ask, why don’t REITs just keep more floating-rate loans to benefit from rate cuts? Well, because that’s risky. If rates don’t fall, or worse, rise again, the REITs could suffer higher costs. That’s why most REITs hedge a large portion of their debt,even though it might seem expensive now, it protects them from uncertainty.

Hence, if rates keep trending down, CDL Hospitality Trust and Far East Hospitality Trust could be among the first REITs to benefit. But remember, this also means they are more exposed if rates rise again. So, position sizing and risk management are key.

Alright, that’s all for today. What do you think? Are REITs finally setting up for a comeback, or do you think investors are right to stay cautious? Let me know in the comments!

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Until next time, happy investing!