Sector review - Real Estate Investment Trusts (REITS), what metric do we look out for, during this pandemic?

Sector review - Real Estate Investment Trusts (REITS), what metric do we look out for, during this pandemic?
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Real Estate Investment Trusts (REITS) are companies that owns, operates, or finances income-generating real estate. REITS pool the capital of numerous investors together in a collective investment scheme that invests in a portfolio of income generating real estate assets such as shopping malls, offices, hotels or serviced apartments.

This makes it possible for individual investors to earn dividends from real estate investments-without having to buy, manage, or finance any properties themselves.

Currently, there are several types of REITS listed on SGX. The following is a list of categories of REITS that investors can invest in and the type of properties that they own:

Commercial REITS - office buildings

  • Retail REITS - Shopping malls
  • Industrial REITS - Warehouses, Logistics facilities
  • Hospitality REITS - Hotels and Serviced residences
  • Healthcare REITS - Hospitals and Nursing homes

​Latest development in the REITS sector

With the Covid-19 pandemic impacting the overall REITS sector, The Ministry of Finance (MOF), the Inland Revenue Authority of Singapore (IRAS), and the Monetary Authority of Singapore (MAS) recently announced new measures to provide REITS with greater flexibility to manage their cash flows and raise funds amid a challenging operating environment.

The measures comprise of the following:

  • Extension of the deadline for distribution of taxable income
  • Increase of the leverage limit to 50 per cent and
  • Deferment of new regulatory requirements such as the minimum interest coverage ratio of 2.5 times and above

Recently, the government has also introduced new amendments to the Covid-19 regulation. The amendments will see commercial property owners providing more rental relief from their own coffers to their Small and Medium Enterprise (SME) tenants.

If the leases or licenses were in force on April 1, 2020, commercial property owners must waive the base rent for two months - June and July - for SME tenants that have seen "significant" revenue declines due to the pandemic.

This will have a significant impact on retail REITS as they will have to set aside more cash on hand to finance the rental relief for their tenants.

In this article, we will be looking at 2 metrics that investors should be looking out for during this pandemic period.

Metric #1 - interest coverage ratio

The Interest Coverage Ratio is a measure of the company's ability in satisfying on-going fixed commitments in the form of interest obligations arising from the use of debt financing out of its available operating profits.

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A metric of 1 or below imply imminent difficulties for the REIT in satisfying its interest obligations. On the other hand, the higher the ratio, the greater the margin of safety as it shows that the REIT is more financially stable and flexible.

However, investors should beware that REITs may not be able to generate the same level of operating profits as before given the current tough operating environment.

Hence, if interest expenses remain unchanged and profits start to decline drastically, there's a chance that a REIT might risk running into insolvency.

Metric #2 - debt to asset ratio (gearing ratio)

Debt to Assets Ratio, or also known as Gearing Ratio, measures the degree of a REIT's financial leverage or indebtedness in financing its assets.

The lower the degree of leverage, the lower the risk of financial distress and bankruptcy as excessive debt can bring about very heavy interest payment and principal repayment burden on the REIT as well as susceptibility to the rise in interest rates or deterioration in the REIT's financial performance.

Nonetheless, REIT investors should also be aware that there might be a high possibility of a devaluation in their properties due to the current downturn in the property market.

This could push up their gearing ratio despite having the same amount of debt in their books.

In a worst-case scenario of breaching the gearing ratio limit, the respective REIT will have to commence corporate exercises such as rights issue to raise funds in order to lower its gearing ratio.

Sector review

Let's take a look at how the REITs are performing based on the above 2 metrics.

Based on the list of REITS, we can see that both ESR REIT and Lippo Mall Trust's interest coverage ratio are well below the upcoming regulation requirement of 2.5 times.

This is a worrying sign for both REITS as this shows that their profit on hand will not be able to pay off their interest expenses adequately.

Furthermore, the gearing ratio for the above-mentioned REITS are on a high side. ESR REIT and Lippo Mall Trust's gearing ratio come in at 43.9 per cent and 41.5 per cent respectively. The current stipulated gearing ratio is at 50 per cent.

For Sabana REIT, SoilbuilBiz REIT and Starhill Global REIT, despite their gearing ratio stands at between 36 per cent - 40 per cent, their interest coverage ratio was slightly below the 2.5 times mark. The interest coverage ratio for these 3 REITS hovers between 2.27 - 2.49 times.

Conclusion

Investors tend to focus on common metrics such as the distribution yield or Price/NAV when it comes to REITs. In this uncertain period which would likely to drag on for some period of time, it makes sense to analyse whether the REITs can continue to stay solvent using the 2 metrics mentioned above.

For the latest updates on the coronavirus, visit here.

This article was first published in Investor-One

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