More S-Reits could be at risk of suspending distributions

THE high interest rate environment has been punishing for locally-listed real estate investment trusts (S-Reits) amid rising finance costs, and valuations also coming under pressure

As at the latest financial results for the financial period ended Dec 2023, six of the 40 S-Reits and property trusts have partly or fully halted distributions to unitholders, amid worsening balance sheet metrics.

Analysts are divided over whether more players are at risk of a similar situation in the coming months.

Darren Chan, senior research analyst at Phillip Securities Research, said some Reits might consider halting dividends to ensure gearing remains within regulatory limits.

“This is especially if the Reits are unable to execute a deleveraging strategy to divest assets to pay off some loans,” he said. “Reits that are at risk are those with a higher gearing level above 42 per cent.”

Under the Code on Collective Investment Schemes, S-Reits should not have total borrowings and deferred payments exceeding 45 per cent of the fund’s deposited property.

A Reit may exceed this threshold up to a maximum of 50 per cent, if it has an adjusted interest coverage ratio (ICR) of at least 2.5 times.

But the high interest rate environment and changing market conditions in some sectors have resulted in aggregate leverage ratios climbing as property valuations fall.

As at Dec 2023, there were eight S-Reits with gearing above 42 per cent, data from the financial statements showed.

Of the eight counters, six have already halted or substantially halted their distributions.

Most of those facing challenges have overseas assets. The counters include Indonesia retail Reit Lippo Malls Indonesia Retail Trus t (LMIRT), China-based Dasin Retail Trust and EC World Reit, and the three US office Reits.

LMIRT said in March 2023 that it would cease distribution to holders of its perpetual securities to “conserve capital and cash resources” as it focused on addressing debt obligations. The distribution stopper on perpetual securities also triggered the restriction in distribution to unitholders.

EC World Reit , meanwhile, said last month that it was suspending distributions for H2 2023, “due to insufficient funds” as the sponsor and its subsidiaries continue to be unable to pay its overdue rent receivables under relevant master leases, which account for more than 80 per cent of revenue in 2023.

Dasin Retail Trust had said last year that it was not able to declare distributions as it defaulted on around S$910 million in loans. It has not announced its H2 2023 results.

Elsewhere, the three US Office S-Reits have also been in the headlines, as changing work patterns and an unfavourable borrowing environment weighed on valuations.

Manulife US Reit ’s distributions were halted last year, following a breach in loan covenants after valuations fell. Unitholders approved a recapitalisation plan in December, but distributions would still be halted until end-2025, unless it achieves certain reinstatement conditions.

Keppel Pacific Oak US Reit (KORE) also announced a shock recapitalisation plan in February that involved pre-emptively halting distributions from H2 2023 to H2 2025, after a decline in valuations resulted in increased gearing.

While Prime US Reit still paid cash distributions for H2 2023, DPU fell 91.7 per cent year on year, as it withheld 90 per cent of distributable income.

“It came as a small surprise that all three Singapore-listed US office Reits have halted distributions to varying degrees to preserve capital and to ensure that gearing remains within the Monetary Authority of Singapore’s leverage limits and bank covenants,” Chan said.

He noted that Kore provided the biggest shock, given its healthier level of gearing, but the actions are “short-term pain for long-term gain”.

Apart from those that halted distributions, other Reits with gearing above 42 per cent include UK-based Elite Commercial Reit, as well as Singapore retail and office landlord Suntec Reit.

Both managers have been taking steps to de-lever their balance sheets.

Suntec Reit said at its latest results briefing that it is targeting a sub-40 per cent gearing ratio, and is also looking to divest more strata units.

Meanwhile Elite Commercial Reit completed a £28 million (S$47.8 million) preferential offering earlier this year. The offering would bring aggregate leverage down to 43.7 per cent, from 50 per cent as at Dec 31, 2023. It also said this month that it has obtained a committed offer for debt facilities of up to £135 million from a group of financial institutions.

Besides high gearing, investors may also need to pay attention to ICRs and financial covenants that Reits must adhere to.

Last month, BHG Retail Reit said that its consolidated interest coverage ratio was 1.8 times as at end-2023, lower than the debt covenant ratio required by the banks at 2 times.

However, it said it obtained a waiver covering the period up till Dec 31, 2023 from the banks, and the loans are not due and payable in advance of their maturity date, which remains on Mar 14, 2025.

Veteran Reit investor and chairman of GCP Global Gabriel Yap pointed out that the risks of halted distributions have caused the S-Reit sector to come close to October 2023 lows despite interest rates easing in the later part of last year.

He remains watchful on certain Reits, particularly those that had a continued “callous” approach to acquisitions.

While the high interest rate environment remains a challenge for S-Reits, some analysts are less concerned that others would also have to resort to halting distributions.

“Based on our analysis (and underlying assumption: rate cuts will start to happen in H2 with no recession), we don’t foresee a need for any other S-Reits to halt their distributions in the near future,” RHB research analyst Vijay Natarajan said.

He observed that the most challenging markets and sectors have been in US office, China and Indonesia retail, and the players in these sectors have already announced dividend halts.

“We believe the situation is contained to these Reits and no further contagion effect is expected on the overall sector.”

Investors, however, may still wish to exercise prudence when seeking Reit exposure.

OCBC Investment Research said it continues to prefer quality names with some Singapore asset exposure.

“We also like S-Reits that are prudent with their capital management as they would be more resilient in a higher-for-longer interest rate environment,” the analysts said in a note.

Their overall sector top picks include Frasers Logistics & Commercial Trust , CapitaLand Ascendas Reit , CapitaLand Ascott Trust , Mapletree Industrial Trust and Mapletree Logistics Trust .

On the other hand, their least preferred S-Reits are Suntec Reit and Keppel DC Reit .