Date: May 4, 2020
The ongoing COVID-19 outbreak has wreaked havoc on the global economy and the bottom lines of companies all over the world. Real estate investment trusts or Reits for short, which form a significant segment of the Singapore stock market, have not been spared and many will face significant financial challenges in the months ahead.
To enable Singapore Reits or S-Reits as they are commonly known get through this difficult period, local regulatory authorities and the Government have responded with timely assistance measures. This article will list what these measures are, as well as explain the basic features, risks and the structure of Reits.
1. What are Reits?
Reits are investment vehicles which own and operate income-generating real estate. They are essentially landlords that use the money collected from investors to buy, operate and manage properties such as retail malls, warehouses, offices, hotels and healthcare assets like hospitals and clinics.
The rental collected from the tenants of these properties is then distributed to Reit investors, just like how companies pay dividends to their shareholders.
The terminology is slightly different though – If you have bought into a Reit, you are known as a unitholder and the money paid per unit is known as the distribution per unit or DPU.
From time to time, REITs may also generate a profit by buying property at a relatively low price and selling it later at a relatively higher price. This is called asset recycling.
2. What are some important features of S-Reits?
First, S-Reits enjoy tax exemption provided they distribute at least 90% of their taxable income to shareholders. Without the need to pay corporate tax, investors of S-Reits can thus enjoy a higher distribution for each unit that they own. Until recently, S-Reits had to perform their distributions within 3 months of their financial year-end in order to qualify for tax exemption.
Second, the amount that S-Reits can borrow is capped in order to ensure their debt is kept at manageable levels. This limit is known as the gearing ratio and until recently was 45% of total assets.
Third, the market price and distribution of any Reit, including S-Reits, reflects the market’s overall confidence in the economy, the property market, the returns of the property owned by the Reit and the Reit’s management.
3. What are the risks?
Broadly speaking, all Reits are exposed to three main risks:
- risks to income because of a drop in rental revenue and/or falling occupancy;
- risks to asset values because of downturn in the property market;
- risks of leverage (borrowings) because the Reit has taken on too much debt and/or its cost of debt has increased (perhaps because of a higher risk premium and/or rising interest rates).
A sudden downturn that hits tenants can adversely affect a Reit’s revenue, forming part of income, if those tenants find themselves unable to pay their rent. Those Reits which have anchor operators (e.g. a supermarket or cinema) or globally recognized brands as tenants might not be too badly affected, particularly if those tenants have signed multi-year lease agreements. However, Reits which have a large diverse pool of small tenants (i.e. retail shopping centres) may find themselves facing financial challenges.
Note also that S-Reits have very little reserve – as highlighted earlier, in order to enjoy tax benefits, they have to distribute a minimum of 90% of their income. This means that during a crisis where cash flows are impacted, they do not have much reserves to see them through. They would then have to resort to other means like borrowings and rights issues to raise cash.
Depending on the type of properties owned, different Reits may face different sectoral risks. For example, a Reit which invests mainly in hotels (i.e. an hospitality Reit) is dependent on the number of customers patronizing its restaurants, the number of guests staying in the hotel and average revenue per available room (REVPAR).
4. Measuring the health of Reits
Apart from looking at revenue, income and a Reit’s gearing ratio, another useful measure to look at is its interest coverage ratio. This measures the Reit’s ability to meet its interest payments and is calculated by dividing its earnings before interest and taxes (EBIT) by its interest expenses. According to SGX, the average gearing ratio for Singapore REITs is 35.3% as of 31st March 2020. This is significantly lower than the maximum of 50% permitted by MAS’s most recent regulatory changes.
If the ratio is above 1, then even if the Reit is unable to repay the principal amount of its debt, it is still, theoretically, able to cover its interest expenses.
5. The impact of COVID-19
In line with the whole market, prices of S-Reits have fallen sharply over the past two months, which might give the impression that they make attractive investments. The DPU of the FTSE ST REIT Index was $12.40 at the end of 1Q 2020 compared to $11.10 at the end of 4Q 2019 (source: SGX) and the 12 month average dividend yield of Singapore REITs of 8.7% compares favorably to the STI Index of 5.2%
However, since 1Q financial results have not been released, yet there is very little information to know how the Reits’ DPUs have been and may be affected. Adding to the uncertainty is the possibility that the pandemic may linger for many more months.
Furthermore, because of the sharp decline in customers and travelers and the circuit breaker implemented by the government since April 7, revenue generation is an on-going challenge for almost all sectors of the economy and S-Reits are no exception.
This in turn may lower S-Reits’ financial standings in terms of metrics such as leverage, capital adequacy and valuation, leading to financial problems, such as higher borrowing costs and difficulty in obtaining both debt and equity capital, at precisely the time when it may be critically needed.
One concern is that if S-Reits’ revenues are badly affected, this would then impair their ability to service their debt. This was the case during the US sub-prime crisis of 2008, but on the plus side is that S-Reits have since restructured their debt and repayment schedules and are better positioned today to withstand business downturns.
6. Regulatory assistance for S-Reits during COVID-19
The Monetary Authority of Singapore (MAS) and Inland Revenue of Singapore (IRAS) recently announced measures to help S-Reits mitigate the impact of COVID-19. These measures are:
- More time to make distributions
Instead of the previous 3 months after financial year-end to make distributions and thus enjoy tax benefits, S-Reits are now given up to 12 months. This extension should give more flexibility for REITs to manage their cash flows.
- Gearing ratio raised to 50%
In order to give S-Reits more flexibility in managing their capital structure, the gearing ratio has been raised from 45 to 50%.
- Deferral of minimum interest coverage requirement
A previous proposal by MAS to require REITs to have a minimum interest coverage ratio of at least 2.5 times before permitting REITs to increase their leverage beyond 45% has been deferred.
- Property tax rebate
As part of its Budget stimulus package, the Singapore government has increased the property tax rebates for 2020 to 100% for qualifying commercial properties including hotels.
7. Additional considerations
Investors should note that the property tax rebate comes with a requirement for landlords to pass through the property tax savings to tenants. This means that landlords, including S-Reits, are required to immediately off-set their tenants’ rents with the property tax savings announced in the budget to combat the effects of the Covid-19 pandemic.
Many S-Reits have also rebated back to tenants, partial deposits to off-set the latter’s immediate rentals. The effect of all these will mean a mis-match in the timing of S-Reits’ cash flows, making it difficult for them to pay out dividends at the usual periods.
In addition, a new Bill that gives businesses a reprieve from contractual obligations, including rent payments, could put significant strain on landlords’ finances. The suspension of rent under the Bill could essentially deprive a Reit of its main source of income for up to six months.
Still, despite these concerns, the announced measures are a significant boost to offsetting an S-Reit’s underlying cost structure and should help them weather the current storm. Investors will have better clarity on the pandemic’s impact once S-Reits announce their 1Q results at the end of April.
The Reit Association of Singapore (Reitas) has recently cautioned that distributions to unit holders may be lower in the immediate quarters because of MAS’s extension of the permissible period for the distribution of FY 2020 taxable income, but should improve over subsequent quarters as Singapore real estate investment trusts receive the deferred rentals owed to them.
Investors should keep an eye out for those announcements, whilst bearing in mind that not all Reits are the same. The quality of the Reit’s management and the strength of its sponsor are important factors, as is the need to maintain a diversified portfolio and not put all your eggs in one basket.
Founder, President & CEO
Securities Investors Association (Singapore)