REITs and Interest Rates

_{September 2022}

This article titled “REITs and interest rates” covers a summary of the real estate sector, listed REITs in Kenya and explores the correlation of REIT Share prices with the Central Bank Rate (CBR).

We also look at an analysis of the historical impact of rising yields on the Fahari I-REIT and finally review US REITs and conclude with Sterling REIT Asset Management’s views that global REITs are well positioned for a high interest rate environment.

Real Estate Sector in Kenya

In recent years, the Real estate growth rate has declined significantly from the highs of 2016 (9.8%), followed by a three-year stagnation between 2017 and 2019 (averaging 6.6%). The significant drop to 4.1% in 2020 can be attributed to COVID-19 containment measures that increased vacancies and halted development activities as investors adopted a “wait-and-see approach”.

The real estate sector growth rate is expected to decline to c.6.3% 2022 due to economic uncertainty influenced by the general elections. However, there are pockets of opportunities in specific sectors and locations for real estate developers and investors.

Access to credit in the real estate sector has been recovering gradually with the banking system net domestic credit to the Real Estate sector increasing by 0.5% to KES.414Bn in June 2022, from KES.411.8Bn in June 2021 according to the latest Monthly Economic Indicators Report June 2022, by the Central Bank of Kenya.

Listed REITs in Kenya

There are three listed REITs in Kenya, two of the REITs are accessible to retail investors ILAM I-REIT and Acorn I-REIT(through Vuka) while Acorn D-REIT is only accessible to professional investors (minimum investment is KES.5Mn).  ILAM Fahari I-REIT is quoted on the Main Market Segment of the NSE while Acorn I-REIT and Acorn D-REIT are quoted on the Unquoted Securities Platform (USP) of the NSE.

ILAM Fahari I-REIT was listed in 2015 after raising KES.3.6Bn against KES.12.5Bn on offer. The average price as of 25^th August 2022 was KES.7.16 per share equivalent to a decline of 64.2% from KES.20 recorded in November 2015. The REIT recorded a net loss of KES.124Mn FY2021 on account of a fair value loss on revaluation of investment property and loss of income from the previous anchor tenant, Tuskys who vacated Greenspan Mall, a key property in the portfolio. However in HY2022, there was a turnaround in earnings with net profit reported at KES.86.2Mn compared to KES.42.2Mn in the same period in 2021. This was attributed to Greenspan mall, getting a new anchor tenant.

In 2021, Acorn holdings raised KES.2.1Bn against a targeted amount of KES.7.5Bn representing a 28.4% subscription rate. In the latest Financials HY2022, Acorn’s D-REIT boasts of assets under management of KES.9.3Bn, mainly comprising of assets in investment properties whereas the I-REIT has KES.4.9Bn. The D-REIT posted a net profit of KES.105Mn in HY2022, whereas the I-REIT reported a profit of KES.192Mn. Both the D-REIT and I-REIT began trading at a share price of KES.20 and have since appreciated to KES.23.84 and KES.20.80 respectively, as of 12^th August 2022.

Correlation of listed REITs with the Central Bank Rate (CBR Rate)

The table below indicates that the ILAM Fahari I-REIT, Acorn ASA I-REIT and Acorn ASA D-REIT have a positive correlation with the CBR Rate. Though there is a correlation/ relationship between the REITs and the CBR rate, it is not a causal relationship.

The data below shows that within the 3 months and 6 months of a rate increase, the Fahari I-REIT share price performance dropped significantly in 2016 and 2019 but recovered within 12 months. In 2021, the share price went up within 3 months of a rate increase declined after 6 months and recovered 12 months later. In 2022, the Fahari I-REIT has generated a 12% total return year to date despite rising yields.

From this data, it is clear that the direction of the CBR Rate and yields has no direct relationship with the REIT share price performance.

The Fahari I-REIT share price has been declining steadily since listing despite changes in the CBR rate and yields due to other market forces, primarily the downturn of the Kenyan capital markets and general lack of knowledge and investor confidence in the product. In the medium term we do not expect to see significant uptake of REITs in Kenya and this will continue to have an impact on the performance of the share price, regardless of the direction of interest rates. However as the market matures we expect REITs in Kenya to follow the global trend and remain strong in periods of increasing interest rates such as US REITs highlighted below.

Based on the NAREIT report Nareit T-Tracker®: Quarterly Operating Performance Series; the first complete quarterly measure of the U.S. listed REIT industry’s operating and dividend performance. From the Q2 2022 quarterly report, we observe that REITs remain robust as interest rates increase;

• • • Funds from Operations (FFO) reached an all-time high of US$19.6Bn every sector except specialty and health care achieved quarter over quarter FFO growth, a 9.8% increase from last quarter.
    • Net Operating Income (NOI)reached an all-time high of US$28.5Bn, which is 3.9% higher than last quarter and 9.9% higher than one year ago.
    • Occupancy ratesof all REIT-owned properties increased to 93.7%, the first quarter in which they reached and exceeded pre-pandemic levels.
    • Dividends for equity REITs were US$12.7Bn total, while dividends for mortgage REITS (mREITs) were US$1.9Bn.
    • Net interest expenseas a percent of net operating income (NOI) declined to a record low of 16.8%, from 17.7% in the prior quarter.
    • Leverage ratiosremained low compared to the historical average: Debt to book assets fell over 35 basis points (bps) to 49.5% and debt to market assets rose almost 475 basis points (bps) to 33.1%.
    • Interest coverage increased to 6.1 times.

The data highlights steady occupancy rates, dividend rates and interest coverage ratios with a growth in Net Operating income and record high funds from operations (FFO) that is above pre-pandemic levels. The leverage ratios remained improved and remained low indicating that REITs are well prepared for a higher interest rate environment.

STERLING REIT ASSET MANAGEMENT LIMITED

5^th Floor, Delta Corner Annex

P.O. Box 45080 - 00100

Nairobi

Tel: +254 20 2213914

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