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Are REITs in Danger?

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Singapore’s REITs have been on a tear since the start of 2012, judging by the 40% increase in the FTSE Straits Times Real Estate Investment Trust Index (SGX: FSTAS8670). The FTSE ST REIT index measures the performance of various REITs in Singapore and has demonstrated how yield-hungry investors have been bidding up the prices of REITs in relation to the broader shares market (the Straits Times Index (SGX: ^STI) only increased by around 21% since 2012).

As investors are busy chasing yields, it is worth noting that local REITs have been under scrutiny lately as ratings agency Fitch Ratings said REITs have to look for financing from other sources as they’re not well equipped for ‘interest rate shocks’. Fitch thinks that these REITs might have difficulties refinancing their debts if interest rates rise, as it would make debt more expensive to obtain.

REITs are almost always heavily leveraged entities, and when their debts come due, they can only take on new debt to repay the old one or issue shares for capital for repayment of the debt. As such, any issues regarding REITs’ refinancing capabilities must be noted.

On the other hand, Moody’s, another ratings agency, has notched up the ratings for several REITs including CapitaMall Trust (SGX: C38U), Keppel REIT (SGX: K71U) and Ascendas REIT (SGX: A17U). Moody’s believes that the lowering of the amount of secured debt in relation to unsecured debt for the REITs has given them more flexibility for their financing. Secured debt requires collateral – usually taken to be the REIT’s properties – while unsecured debt does not, making the latter a slightly safer form of debt for the REITs.

However, Moody’s upgrade does not necessarily mean that the REITs are safer. In tougher economic climates such as that experienced in 2007-2009, credit is usually scarce. This can mean that creditors will want even tougher terms for their credit, be it in the form of more collateral or higher interest rates, which is the danger that Fitch was warning about. Low interest rates are prevalent in the current environment but there’s no saying when or if these rates will rise (for example, Japan has been in a near-zero interest rate environment since at 1996).

If interest rates rise, REITs will find that their interest coverage ratios will start to compress and refinancing will become tougher.

The last time Ascendas got downgraded by Moody’s was in 2009 due to possible debt-refinancing difficulties, and further downgrades would have been re-enacted if the ratings agency saw the REIT’s ‘fixed interest coverage dipping below 4’ at that time. In Ascendas’s recent third quarter earnings presentation, its current interest cover ratio was 5 – that’s 20% higher than its previous danger point. 44% of Ascenda’s total debt of $2.19b will be due for refinancing by 2015 and if the REIT has to refinance it at higher interest rates, it might just lower its interest cover ratio, spurring negative action on the part of rating agencies. This can lead to a vicious cycle of:

Downgrades →  pricier debt   interest-payment difficulties   downgrades

All these have a possibility of happening, but nobody can know for sure if it will really happen. How can we lessen such risks though? Well, the answer’s simple – we can look for REITs with higher interest coverage ratios and a smaller ratio of Debts/Assets or Gearing. After all, no company or trust ever went bankrupt by taking on no debt.

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The Motley Fool’s purpose is to help the world invest, better.   The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Contributor Chong Ser Jing doesn’t own shares in any companies mentioned.