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Industrial REITs As A Hedge Against Stagflation

April 18, 2022

While global economic growth shows signs of slowing as the U.S. Federal Reserve tapers its stimulus and increases interest rates, inflation remains elevated, thanks to supply chain disruptions, sanctions against Russia and sky-high energy costs. 

Against this backdrop, we ask Junnosuke Shinkawa, Chief Analyst at Sumitomo Mitsui DS Asset Management Singapore, about his views on rising rates, inflation, and REITs’ outlook in Asia.

Q1) How will rising inflation impact REITs?

The most immediate effect of rising inflation is the negative impact on profit margins through higher operating expenses, including wages and utility costs. The other negative aspect of rising inflation is that it could adversely affect consumer sentiment and retail spending. It could also affect the profitability of tenants and erode their occupancy costs. However, landlords can adjust for inflation over the long term through higher rents, and rental increases are likely to mitigate underlying inflation pressures for REITs.

Q2) What are the implications of rising interest rates?

Rising interest rates pose a greater risk for REITs through, firstly, higher borrowing costs, increasing their overall cost of capital and lowering their net income. Secondly, higher long-bond yields will erode the attractiveness of Singapore-REIT (S-REIT) yields versus risk-free benchmarks. Higher long-bond yields could also have a negative impact on capital values since it will also make the real estate asset class less attractive, leading to a possible correction in asset values.

Q3) What is your outlook on the Asia Pacific REIT markets?

Higher long bond yields are a headwind for REITs’ share price performance, but a lot of the concerns over rising bond yields have been in the price. Despite rising 10-year bond yields and short-term rates, we have seen more flattening of the yield curve, which has actually been positive for S-REIT performance. Also, we believe that the re-opening play, such as retail and hospitality REITs, have largely priced in. Investors would start rotating into industrial REITs as a hedge against the risk of an inverted yield curve and prospects of stagflation concerns by year-end.