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Rising Interest Rates A Risk To A-REIT Valuations, S&P Global Ratings Says

The ratings agency, however, said REITs in Australia are still well-positioned for higher rates – for now.

Analysis by Craig Parker, analyst at S&P Global Ratings.

September 12, 2022 – “For the REIT sector, rising interest rates remain a risk to valuations, cash flows, and credit quality. However, the REITs we rate are relatively well positioned for the next 12 months. Long-dated debt, conservative interest-rate hedging profiles and contracted rental growth should help to protect their cash flow and earnings.

“This contrasts with the prevalence of short-dated debt and limited hedging of many REITs leading into the 2008 financial crisis. Over the next two to three years, however, we anticipate higher rates will squeeze REITs’ free cash flow generation and credit measures as interest rate hedges roll off.

“Demand for prime office space in central business districts should hold up relatively well over the next few years. This is despite the structural change associated with online retailing and work-from-home trends. Space users are likely to migrate toward the higher-end and more environmentally friendly buildings owned by our rated REITs as their space demands reduce with hybrid work arrangements. Office rental levels may suffer as the market adjusts to this potential demand-supply imbalance.

“The shift to hybrid working is also causing behavioral change in commuting. The switch from public transport to private vehicles for work travel supports demand for Transurban Group‘s toll roads.

“Tenant demand for space in high-quality shopping centers, such as those owned by Scentre Group and Vicinity Centres, is proving resilient even as some retailers reduce their number of physical stores. Online shopping will continue to limit space demand from individual retailers, but we believe the better positioned centers will continue to evolve their tenancy mix and remain a gathering point for communities.

“The surge in online retailing is maintaining demand for logistics space. Strategically positioned urban-infill sites help to mitigate supply-chain and distribution disruptions for retailers. Operators such as Goodman Group have benefited from this demand while companies such as GPT Group and Stockland Corp. Ltd. have increased capital allocation toward logistics assets.

“The operating landscape continues to evolve. Rising rates, higher costs and a slowdown in demand will put a healthy Australia Inc. to the test. Companies with superior balance sheet strength, pricing power and nimble operating strategies will be best placed to deal with these multiple challenges.”