Higher gearing limits will improve Reits' DPU

Singapore

THE proposed higher leverage limits for real estate investment trusts (Reits) could lower overall cost of capital for the asset class, and allow room for portfolio growth, given the greater certainty of deal completions.

In addition, distribution to unitholders could also increase, as debt-funded property acquisitions are likely to be accretive to distribution per unit (DPU) since the rental yields of the acquired assets will probably exceed the interest rate of borrowings.

Higher leverage limits could also reduce the incidences of Reits issuing perpetual securities (perps) to raise funds. Perps - essentially bonds with no maturity date - are an alternative that Reits use to get around gearing limits, since they are treated as equity. Perp coupon rates are typically higher than the interest rates on bonds or loans, which consequently reduce DPUs.

These were analysts' thoughts on the Monetary Authority of Singapore's (MAS) proposal announced on Tuesday to raise leverage limits for Reits from the current 45 per cent to 50 per cent or more, coupled with other checks and balances such as minimum interest coverage ratio (ICR).

On Thursday, most Reits finished in positive territory, with the biggest gainers being Lippo Malls Indonesia Retail Trust (up 4.4 per cent), CapitaLand Mall Trust (up 3 per cent), and Fortune Reit (up 2.9 per cent).

Wilson Ng, equity analyst at Morgan Stanley, said: "If implemented, we believe higher gearing limits would be a net positive for Singapore Reits as it could drive higher DPUs, and help level the playing field in property acquisitions where other competing bidders may be subject to less stringent leverage limits."

The downside would be that higher gearing levels could encourage Reit managers to engage in more acquisition activity to generate fees for the manager, which may not be in the best interests of unitholders. Higher gearing levels may also not be well received by market participants, which may penalise Reits with higher gearing with lower stock valuations, Mr Ng added.

Across the sector, Singapore Reits appear to be still in the pink of health, with an average gearing of 34.9 per cent, and ICR of 5.8 times. This also means that if the proposal is implemented, most of the Reits will likely be able to gear above 45 per cent, to even close to 55 per cent.

DBS analyst Mervin Song also believes that a minimum ICR can provide sufficient safeguards against investors' concerns about higher gearing. Another safeguard already in place is the fact that with S-Reits progressively expanding overseas, they have also been taking on additional non-SGD debt as a natural hedge. This would serve as a prudent risk-mitigating strategy, he said.

One thing that most analysts agree on is that the stock market will also self-regulate, and punish Reits that gear up too aggressively with low valuations.

OCBC Investment Research noted that in the past, even when Reits were allowed to gear up to 60 per cent if they had a credit rating, they chose to remain conservative and kept their leverage below 45 per cent. If anything, they would use debt to close the deal first as a temporary measure, then raise equity in the future if need be.

Priyaranjan Kumar, regional executive director, capital markets, Asia-Pacific at Cushman & Wakefield, agreed, saying: "Many other Reit jurisdictions around the world do not impose mandatory leverage limits and instead rely on public markets to assess prudence on how much debt is accretive to shareholder returns.

"Over the past decade, there is enough data to illustrate that investors have rewarded Reits who have taken optimum credit without affecting quality of earnings, and punished those who have been indiscriminate and attracted poor credit ratings."

He said MAS's move was "forward thinking", given rising asset valuations globally against a backdrop of persistently low interest rates.

He added that if investors are still concerned about high gearing, besides traditional liquidity ratios such as ICRs, MAS can also regulate prudence by imposing loan-to-value limits at the asset level combined with a Reit-level leverage, and perhaps compulsory ratings from two agencies for any Reit than exceeds 55-per-cent overall debt limits.

"Besides driving competitiveness of Reits being able to acquire assets, the relaxation of debt limits will also reward equity shareholders who will face fewer instances of dilution with every substantial acquisition," he added.

Most Reits said a higher leverage limit would benefit them - but not all.

Manulife US Reit, for instance, said that a higher gearing limit would increase the Reit's debt headroom for acquisitions and allow it to do deals that are more accretive for unitholders, funded with more debt than equity. It will also enable the Reit to buy higher quality assets in the US.

In contrast, Frasers Logistics & Industrial Trust feels more comfortable with a gearing in the 30s range, and said it is unlikely to venture into a gearing above 50 per cent.

The Reit manager's chief financial officer Susanna Cher said: "Property cycles come up and down, so we need a buffer, and nobody wants to go touch 40 per cent. But if you're in a third-party acquisition, the private equity funds can get 70 per cent debt funding for those transactions, and a Reit could never and should never participate and compete in that kind of transactions."

- ADDITIONAL REPORTING BY FIONA LAM