SINGAPORE – If the proposed changes of raising the leverage limit of Singapore real estate investment trusts (S-Reits) above the current leverage limit of 45 per cent goes through, debt markets can no longer take a “broad-brush” approach and assume S-Reits are “low-risk”.
Instead, Reits need to be assessed on a case by case basis as the financial discipline of their managers is crucial, said OCBC credit analyst Seow Zhi Qi. This was in response to the Monetary Authority of Singapore’s (MAS) consultation paper proposing changes on the Singapore Reits sector released earlier this month.
Although Reits would be able to make acquisitions and propel earnings with a large debt headroom given by a higher leverage limit, there may be higher credit risk.
This is because some properties may not have been accretive for unitholders based on the 45 per cent leverage limit, but accretive to unitholders with a 50 to 55 per cent leverage limit, as more debt can be used to fund the acquisition versus using more equity.
Moreover, Reits have also been seen as a “lower risk and low growth” asset class able to generate stable income to pay capital source providers such as bank debt, bonds, perpetual and equity holders.
“As such, it is questionable whether growth in and of itself is a good thing for bondholders,” Ms Seow said.
In addition, a higher leverage limit may also weaken the credit metrics of Reits which have historically and generally kept their aggregate leverage within 40 per cent despite the allowed limit of 45 per cent.
Stretching their leverage to 50 to 55 per cent would broadly translate to a net gearing of 1.0 to 1.2 times, which OCBC said is higher than its net estimate average net gearing of 0.53 times as at March 31.
With changes to the aggregate leverage, the net gearing of Reits, typically lower than that of property developers, could inch higher and come close to property developers’.
Ms Seow added that the proposed changes will likely benefit perpetual holders of healthy Reits, as well as the sponsors of the Reits.
Perp holders will benefit as the call risk of perpetual of healthy Reits would disappear due to enlarged debt headroom. It can then raise “relatively cheaper” senior debt to refinance its perps at first call for non-trivial cost savings.
“Consequentially, over the medium term, we can expect fewer Reit perpetuals to come to market and instead continue to see senior debt issuances,” she added.
Meanwhile, sponsors would benefit as they would be able to inject properties with greater ease into the Reits from a financial standpoint, including sizeable ones. This is because the cost of debt is lower than the cost of equity.
OCBC is of the view that more properties would become accretive to unitholders on a levered basis and “getting blessed by unitholders”.
As sponsors also typically own at least part of the Reit’s managers and Reit manager fees tend to be linked to asset bases, having a sponsor pipeline is beneficial to Reits in terms of growth, although this benefit to bondholders is “less apparent given bondholders do not share in the upside”, Ms Seow added.
Lastly, raising the leverage limit would help bolster the competitiveness of the Singapore Exchange, whose leverage limit is currently at the “stricter end” of the spectrum.
While Singapore and Hong Kong impose a leverage limit of 45 per cent, Malaysia imposes 50 per cent, while Thailand allows a leverage limit of up to 60 per cent with an investment grade credit rating. The US meanwhile, does not impose any leverage limit.
Safeguards suggested by OCBC in relation to raising the leverage limit include a tighter Ebitda/interest coverage than the suggested 2.5 times – where Ebitda is earnings before interest, taxes, depreciation, and amortisation, and a cap on the secured debt a Reit could take relative to its total asset value.