SINGAPORE (July 10): In an effort to allow Singapore REITs (S-REITs) to better optimise their capital structure, the Monetary Authority of Singapore (MAS) last week announced that it is considering increasing the current gearing limit to 45%.
See: MAS proposing changes to S-REIT capital structure rules and fundraising process
The central bank released a consultation paper to review this move and is seeking feedback from the industry on whether the use of interest coverage ratio with a leverage limit is appropriate or if there are any other approaches or credit metrics to determine the amount of leverage.
MAS is also asking for comments on two options: 50% gearing limit subject to a minimum interest coverage ratio (ICR) of 2.5 times after taking into account the interest payments arising from the new debt; and 55% gearing limit but having a higher ICR threshold.
In addition, MAS is proposing for S-REITs to disclose their leverage ratios and ICRs in their interim financial results and annual reports, as well as to standardise the definition of ICR.
All comments have to be submitted by Aug 1.
This move came on the back of the industry giving feedback that a higher gearing limit is required to give local REITs more flexibility, especially when acquiring overseas assets from third parties and face competition from private equity funds and/or developers which have higher gearing limits.
Such circumstances are highly time sensitive and put S-REITs in a position where they might miss out on the acquisition due to more time needed to raise equity, rather than funding with debt.
As at May 31, the gearing level for S-REITs averaged about 34%.
This move may be essential if S-REITs want to see more growth, as analysts and investors are questioning if the rally in S-REITs still has legs, according to Bloomberg.
See: Does the Singapore REIT rally still have room to run after surging 18% this year?
With S-REITs gaining more than twice as much the broader equity market, and the FTSE Straits Times Real Estate Investment Trust Index surging 18% this year, S-REITs are starting to look overvalued.
Although investors might be worried about the higher gearing, in a July 3 report, DBS Group Research lead analyst Mervin Song believes that having a minimum ICR may provide sufficient safeguards.
“While a higher gearing may be a ‘double edge sword’, given most S-REITs and their sponsors are experienced property managers, we believe they would be aware of the dangers of gearing up in the later stages of the economic or property cycle. Finally, the market would keep the REITs in check should they 'misuse' this extra debt headroom,” says Song.
Therefore, he believes that the increase in gearing limit will bode well for the overall sector and help S-REITs fund value accretive acquisitions.
In an earlier DBS report on June 27, Song mentioned that the research house’s bull call on S-REITs since the start of the year was a profitable trade, but notwithstanding potential profit-taking along the way, the next leg up should be more modest and gradual.
“This should be driven by DPU growth as S-REITS benefit from tailwinds of an upturn in the Singapore property sector and a dovish Federal Reserve,” says Song.
Similarly, CGS-CIMB Research has kept its “overweight” rating on S-REITs in view of the protracted low interest rate outlook.
In a July 3 report, analyst Lock Mun Yee says, “Accretive acquisitions on the back of lower cost of capital could provide additional tailwinds to the SREIT sector.”
As at end-1Q19, the sector’s gearing stands at 36.6%, and Lock believes that S-REITs are well positioned to explore inorganic growth opportunities.
“In addition, S-REITs could potentially benefit from lower funding cost on refinancing. Recent proposal by MAS to review leverage limits and streamline fundraising process to provide S-REITs greater flexibility to manage their capital structure could further fuel inorganic growth prospects for the sector,” adds Lock.
