Rate cuts will give S-Reits a boost, but don’t expect a return to the glory days soon

THE US Federal Reserve’s long-awaited interest-rate cut spells relief for global markets, which have had to cope with rate hikes since March 2022.

Before the super-sized rate cut of half a percentage point last week, interest rates had soared from around zero to 5.5 per cent.

In particular, Singapore-listed real estate investment trusts (S-Reits) will breathe a sigh of relief.

S-Reits have had to contend with higher borrowing costs in recent years, which have eaten into distributions and dampened investor sentiment.

The turnaround in interest rates has raised hopes among market watchers and investors, who are anticipating a boost to S-Reits.

Shortly after the rate cuts were announced, the iEdge S-Reit Index, which tracks the performance of S-Reits, rose 1.7 per cent on Sep 19. Pure-play US office S-Reits – Manulife US Reit, Prime US Reit and Keppel Pacific Oak Reit – also hit highs when the Singapore markets opened for trade after the rate cuts.

Tempering expectations

While S-Reits will benefit from the lower interest rates, investors expecting a return to the glory days of near-zero interest rates should temper their expectations.

Firstly, rate cuts, which were already expected to be due sometime this year, have been priced into S-Reits to some extent.

The iEdge S-Reit Index, for instance, has been trending upwards since hitting its 52-week low in late October 2023 as concerns over inflation eased.

Although the larger-than-expected rate cut last week bodes well for S-Reits’ future performance, it is worth noting that the pace and size of future cuts remain uncertain going forward.

For now, the Fed has forecast another half percentage point cut this year, followed by a full percentage point next year, and a half percentage point in 2026.

If the Fed follows through, this will bring interest rates to around 3 per cent by 2026. This figure is still far from the lows seen before the rate hike cycle began.

However, as Charu Chanana, the head of FX strategy at investment bank Saxo, pointed out in her analysis, there is still “immense uncertainty” on the path ahead for the US central bank.

Chanana noted that the Fed will have to balance various competing economic forces when deciding on future rate cuts.

She said that there is a diversion in the dot plot, which forecasts the Federal Open Market Committee members’ expectations in future interest rate movements. The diversion suggests that there could be differences among policymakers in future on rate cut decisions, added Chanana.

Should the Fed choose to be conservative, the runway for S-Reits to recover will be longer.

“Higher for longer” here to stay

Regardless of how deep the initial round of cuts are, it seems that the higher-for-longer interest rate environment is here to stay.

Many factors, including employment data, inflation prints and even the next US administration, will influence the subsequent rate cut decisions.

As it stands, there are indications that subsequent rate cuts could be drawn out. Unemployment in the US is on the rise, and inflation is not fully under control yet, hovering just above the Fed’s target of 2 per cent. There are also jitters about a possible recession.

It will also take at least a year before the impact of rate cuts starts to translate into better bottom lines for S-Reits, with a knock-on effect on their distributions.

The impact of rate cuts will also be uneven across the Reit sector.

Analysts had previously told The Business Times that they expect S-Reits with a lower proportion of fixed-rate debt to benefit sooner from rate cuts. Those that have a higher level of debt due to be refinanced over the next one-and-a-half years also stand to benefit sooner from rate cuts.

In short, while investors can look forward to S-Reits benefiting from rate cuts, the benefits won’t translate into an immediate turnaround in the Reit sector.

Rather, the improvements in S-Reits are likely to be slow and steady, in tandem with what are likely to be incremental rate cuts over the next few years. It will be some time before S-Reits reach the highs seen before the interest rate hike cycle.