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Singapore landlords discover perpetual debt is the new equity

[SINGAPORE] Singapore landlords are loading up on bonds masked as equity to get around new rules curbing their debt amid a property slump.

Real-estate investment trusts issued a record S$700 million of perpetual notes with no set maturity date in 2015 and they're likely to sell more, according to Fitch Ratings. The Monetary Authority of Singapore is capping borrowings of REITs at 45 per cent of assets from next year and debt that can be considered equity offers landlords a way of complying with the stricter rules.

Falling values, rents and occupancies for debt-backed properties could tip Singapore's economy further into trouble amid the slowest growth in three years. Office rents may fall as much as 7 per cent this year and another 8 per cent in 2016 as demand slows, according to DTZ, while house prices keep declining. Global non-financial companies seeking to cut their leverage have issued more than US$50 billion of perpetuals this year.

"With the lower leverage threshold, there might be more Singapore REITs who will look to tap this source of funding given it is still treated as equity instead of debt," said Singapore-based Tim Gibson, co-head of global property equities at Henderson Global Investors Ltd. His firm manages about US$123 billion worldwide. "Investors continue to seek yield in this environment." On Oct 26, office landlord Keppel REIT sold S$150 million of perpetual debt without a so-called step-up coupon, a gradually rising interest rate that's usually a feature of such bonds. It sold the notes at 4.98 per cent, 183 basis points more than seven-year debt it sold in February. In the same month, business park owner Ascendas REIT raised S$300 million issuing similar notes, while apartments specialist Ascott Residence Trust issued S$250 million of them in June.

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Under global accounting rules, bonds with no fixed maturity that allow the deferral of coupon payments may be treated as equity. Singapore regulators will insist REITs' notes meet those requirements, as well as having no step-up in interest rates and being subordinate to other creditors. While such features reduce the allure for investors, they benefit property owners when falling asset values cause their leverage to rise.

The value of Singapore's office buildings fell 0.1 per cent in the quarter ending Sept 30 from the previous three months while shops declined 0.3 per cent, according to the Urban Redevelopment Authority. House prices dropped 1.3 per cent, the most since the second quarter of 2009, according to data compiled by Bloomberg.

The FTSE Straits Times Real Estate Investment Trust Index has dropped 11.4 per cent this year, on course for its worst annual performance since 2011.

"Most Singapore listed REITS have good credit quality," said Neel Gopalakrishnan, an emerging markets fixed income analyst at Credit Suisse Group AG's private banking and wealth management unit in Singapore. "Hence, there is likely to be good demand" for their perpetuals.

Singapore's more than 30 listed REITs had an average debt to asset ratio of 34.6 per cent at the end of September, versus 32.8 per cent from a year earlier, according to data compiled by Bloomberg. OUE Hospitality Trust had the highest leverage at about 41.9 per cent, up from 32.4 per cent over that time. It didn't respond to e-mail and phone calls seeking comment.

Frasers Hospitality Trust, whose leverage stood at 38.9 per cent versus 39.1 per cent on March 31, maintains a prudent approach to capital management strategy and would employ an appropriate mix of debt and equity to maximize returns to shareholders, it said by e-mail on Monday.

The new cap on REITs' borrowings takes effect from Jan 1, and leaves smaller room for some to take on new debt to fund acquisitions or repair their balance sheets, according to Fitch. The threshold replaces existing limits of 60 per cent for rated trusts and 35 per cent for those without a credit score, the Monetary Authority of Singapore decided in July.

Singapore's listed REITs could issue as much as S$12.5 billion of traditional debt without breaching the new threshold, Hasira De Silva, a Singapore-based analyst at Fitch said in an interview. That leeway narrows to S$7.5 billion if their S$110 billion of assets suffer a 10 per cent depreciation, he said. That's based on their 34 per cent leverage at the end of September.

"The perpetual will be used by Singapore REITs in 2016 to fix balance sheets as required, because we expect more pressure on asset values then," De Silva said.

Buyers of the notes will tend to be individuals rather than funds, according to Deutsche Bank AG. That could translate into higher volatility.

"Most of the demand for Singapore dollar perpetuals has been from retail investors," said Vishal Goenka, head of local currency credit in Singapore at Deutsche Bank. "As issuance of perpetuals picks up in future, caution is advised in a higher interest-rate environment."