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What is Gearing Ratio?

Gearing is a measure of financial leverage of a company or a real estate investment trust (REIT).

For companies, examples of gearing ratios include the debt-to-equity ratio (total debt / total equity) or and debt ratio (total debt / total assets). A company with a high leverage is more vulnerable to downturns during a recession as it has to continue servicing its debt regardless of how bad the earnings are. In extreme cases, the company may go into bankruptcy if it is unable to pay off its loans.

For a REIT, gearing ratio is the total borrowings (both short-term and long-term) divided by total assets. In Singapore, REITs without a credit rating from Moody’s, Standard & Poor’s or Fitch Gearing have to cap their gearing ratio to below 35%, as stipulated by the Monetary Authority of Singapore’s Code on Collective Investment Schemes. The gearing ratio may exceed 35% and up to a maximum of 60% only if a credit rating is obtained from the above-mentioned agencies and disclosed to the public.

The gearing ratio for REITs is a highly watched figure for investors as most REITs roll-on their debt. That means that borrowings that are going to mature in the near-term are refinanced with a longer term maturity. If the banks freeze up, as seen during the sub-prime crisis, REITs with high leverage may have a hard time to re-finance their loans. This may result in the REIT having to undertake dilutive rights issues or even sell properties at distressed levels to re-pay their debt.