Singapore REITs Sector – Some breathing room for REITs (+ Credit Commentary) April 17, 2020 461

  • Extension of timeline for REITS to distribute at least 90% of earnings from 3 to 12 months
  • Gearing limit raised from 45% to 50%; 2.5x ICR prerequisite for higher gearing of 50% deferred until 1 January 2022
  • Share issue limit for shares and convertible securities raised to 100% of share capital (prev. 50%)
  • Leverage limits and enhanced share issue limit in this low interest rate environment is presenting attractive conditions for REITs to acquire. Possible re-rating if REITs choose to tap leverage headroom

 

Measures to provide S-REITs flexibility amidst COVID-19

On 16 April 2020, the Ministry of Finance (MOF), the Inland Revenue Authority of Singapore (IRAS) announced the extension of timeline for REITs to distribute at least 90% their earnings. S-REITs with FY2020 ending 31 March 2020 and 31 December 2020 will have up to 31 March 2021 and 31 December 2021 respectively, to distribute to their unitholders at least 90% of their taxable income derived in FY2020 to qualify for tax transparency.

Meanwhile, the Monetary Authority of Singapore (MAS) raised the leverage limit for S-REITS from 45% to 50%, without the 2.5x ICR prerequisite for higher gearing of 50% (deferred until 1 January 2022).

This comes after the SGX RegCo’s 8 April 2020 “Enhanced Share Issue Limit” announcement, allowing Mainboard issuers to issue shares and convertible securities up to 100% of its share capital, enabling the acceleration of fund-raising efforts.

These measures were in response to concerns raise by REITAS over the COVID-19 Bill passed on 7 April 2022. Viewed together, these measures will allow S-REITs to have continued access to different funding channels, including borrowing from banks, issuing bonds, and raising equity. 

 

The COVID-19 (Temporary Measures) Bill was passed in parliament on 7 April 2020. The bill provides temporary relief for the inability to perform contractual obligations, including non-residential leases. Landlords are unable to take the following actions against tenants seeking relief under the bill:

  1. Commencing or continuing legal action;
  2. Making an application for winding up, bankruptcy; or for a Judicial Management Order;
  3. Terminating a lease or license of immovable property, for non-payment of rent. Landlords can, however, use the security deposit to offset rental payments due, because that doesn’t create additional cash-flow obligations on the tenant;
  4. Enforcement of any security over immovable or movable property

 

Tenants seeking relief under the bill must show that they are unable to pay rent during the period commencing 1 February 2020, and that the inability to pay is to a material extent caused by a COVID-19 event. Tenant-landlords disputes on eligibility of relief will be escalated to the Assessors, who will make a final, non-appealable decision on the eligibility of the tenant.

 

What do we think?

SREITs seemed to have drawn the shorter end of the straw under the COVID-19 Bill. Nonetheless, REITs still have an arsenal of methods to help them cushion the blow from the mismatch in cashflows due to the 6 to 12-month rental deferment period. REITs can conserve cash by:

  1. Receiving management fees in units
  2. Passing on savings from management pay cuts or government wage share to unitholders
  3. Altering the payout ratio to smoothen out distributions, dispersing the impact of reduced cashflows/revenue over several quarters
  4. Conserve cash by deferring or cutting discretionary operating expenses (e.g. marketing expenses and non-critical repair and maintenance).
  5. Embark on acquisitions to shore up earnings

 

For tenants claiming relief under the COVID-19 Bill for rental deferment, landlords will not be able to collect cash rent for but may use the security deposits to offset the accrued rental. This will help to mitigate the cashflow mismatch REITs face. Landlords typically collect 2 to 4 months rents as security deposit.

Over the years, S-REITs have built a reputation for being credible, prudent, stable and financially disciplined. We are of the view that S-REITs will respond in a measured and sensible manner. The extension of timeline to distribute earnings will definitely help S-REITs to plan and manage their cashflow mismatch however rental rebates offered by REITs will result in lower distributable incomes. We think that will cut DPUs if necessary, safeguarding their future growth by preventing short-term disruptions from having a prolonged effect, or changing their trajectory. While unsavory, the COVID-19 pandemic is a system-wide shock that negatively affects almost every industry, including REITs.

Higher leverage limits will give REITs buffer should asset valuations start to deteriorate. Asset quality will deteriorate should arrears pile up and REITs may start to recognize bad debt provisions. The increased leverage limits will provide for revaluation downside and well as allow room for bad debt provisioning.

Once shoots of recovery appear, REITs will start to notice the at attractive acquisition conditions the higher of leverage limits and enhanced share issue limit in this low interest rate environment present – provided REITs are willing to gear up. 2019 was a year of acquisitions for the REITs with many SREITs that we have spoken to coming into 2020 with deal evaluations underway. While equity valuations were not as attractive relative to 2019, accretive deals can still be structured by utilizing their higher leverage limit bandwidth.

S-REITs have largely moved in lockstep and have been known to be conservative, with sector average gearing in the 33% to 36% range, below the previous 45% leverage limit. The COVID-19 situation may be the re-rating catalyst that helps SREITs overcome their prudence and tap into their gearing headroom.

With interest rates expected to remain low to aid business recovery, REITs will likely resume the acquisition momentum once we are out of the virus pandemic, which may lead to a strong recovery for the S-REITs sector.

 

Credit commentary

Whilst increasing the leverage limit could hamper REIT credit metrics by increasing gearing ratios and reducing interest cover, the key goal now is to tide over the current downturn. We view support from the government such as through distribution deferment to help REITs with cash flow and earnings as a credit positive, however offset by possible deterioration of REIT credit metrics. Note that with the ability to take on more debt may provide REITs with more headroom to refinance their higher coupon perpetual bonds with lower rate bank loans. This could reduce non-call risk for REIT perps.

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Hock Meng
Hock Meng

Question on the proposed new legislation and impacts on the S-Reit sector, may I know, going back to the Letter to Editor commentary published by The Business Times newspaper on whether the Reit managers will also need to reduce their management fees, or to take significant pay cuts, as opposed to cutting dividends to unitholders. Reason being, most, if not all Reit managers, are typically rewarded by AUM size, rather than to focus on increasing the DPU, which is supposed… Read more »

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