What Is the Impact of Rising Rates?

Market view: Re-emerging concerns of a conclusion to QE and cheap funding have led to an increasing focus on the risk of rising interest rates.

Our view: We think a rise in short rates in 2015 does not pose an immediate threat to borrowing costs, which are generally well hedged. Rising long rates could be coincident with further yield compression, especially if growth prospects improve.

Borrowing Cost Impact: Hedged Short end of curve not rising as much: US 10-year government bond yields have expanded 35bps YTD to 2.1%.

Our US interest rate strategy team expects further expansion to 2.29% by 4Q13 and 2.46% by 1Q14. Yet at the shorter end of the curve, 3-month US treasury yields are still ~0.05%. Our US economics team expects the benchmarked Fed Funds Rate to remain at 0.15% through 2014.

Singapore interest rates could show a similar trend, given how they track US rates to achieve interest rate parity. Singapore 10-year government bond yields have mirrored the US increase, rising 53bps YTD to 1.8%, and our ASEAN economics team sees shorter term 3M-SIBOR holding at 0.4% through 2014. 3M-SIBOR is the benchmark rate lenders tend to use, and the risk of that rising seems muted in the near term.

Borrowing cost exposure well hedged: Since the GFC, REITs have spread out debt maturities to reduce funding risks.

They have also been locking in fixed rates in anticipation of an eventual interest rate rise. REITs under our coverage have ~70% of debt hedged against interest rate exposure, and ~20% is due for refinancing each year. What this means is that when borrowing costs do rise, the impact is likely relatively muted – we estimate the immediate impact of a 1ppt rise is ~3% on div/shr, and 9% eventually, spread over the maturity of fixed-rate debt and swaps.