The Monetary Authority of Singapore (MAS) had recently proposed changes to be made to the regulations governing the real estate investment trust (REIT) market in Singapore. For me, one of the most interesting changes involves the leverage limit to which REITs are subjected to.
Under the current rules, REITs are allowed to borrow up to 35% of their total assets; the limit can be bumped up to 60% if the REIT obtains a credit rating from a ratings agency and discloses it to the public. MAS’s proposal is to have a single-tier leverage limit of 45% and to “remove the option for a REIT to leverage up to 60% by obtaining a credit rating.”
Now, giving all REITs the ability to increase their borrowings (without the need for a credit rating) is not inherently bad – after all, leverage, when used judiciously, can result in better shareholder returns. But, it also pays to look back at history to see what can happen when REITs were given freer rein to borrow more across the board. We can then use that as a basis to make some judgements on what to look out for in the future.
We’ve not had such a scenario in Singapore, but Australian real estate investment trusts (AREITs) have had much more freedom to borrow. And there are some lessons to be gleaned.
During the Great Financial Crisis of 2007-09, the AREITs suffered badly as a group, falling 8.4% and 55.3% in price in 2007 and 2008 respectively. “Over-gearing was the biggest problem” for the REITs, according to an article from The Age titled “Turnaround rebuilds trust.”
There’s a poetic-symmetry in noting that the average gearing level for AREITs had steadily rose from 15% in the 1990s to a peak of 45% in 2006 and 2007 before the crisis hit. When the crisis came, “debt markets froze” and a number of AREITs couldn’t refinance their borrowings as a result. The Age added that “[o]ne of Australia’s biggest corporate failures during the GFC, Centro, collapsed for this reason.”
Besides learning about the risks of taking on higher leverage, one other lesson that AREITs took away was the importance of having many different sources of capital. According to Peter Davidson who was interviewed in the article by The Age, “AREIT managers relied too heavily on banks for their debt funding in the pre-GFC years” and suffered when the banks stopped lending.
Applying lessons locally
If we assume that MAS’s proposed changes to the leverage limit comes into effect in the future, then there are two key takeaways Singapore REIT investors can have with the Australian experience.
First, investors would really have to watch for any increases in gearing that their REITs are piling on and make sure that they are comfortable with that. Hitting a leverage ratio of 45% is not a sure-fire threshold to signal catastrophic trouble ahead for a REIT. But, it’s good to note that higher leverage in general, has indeed caused problems for REITs not just theoretically, but in reality.
But investors in Singapore might not have to worry too much about rising leverage – to the credit of REITs in Singapore “most… have kept their leverage ratios within 35%”, according to MAS. This happened even though two-thirds of the REITs here have credit ratings and can thus borrow up to 60% of their total assets.
Second, investors would have to observe for changes in the sources of borrowings that a REIT has. If we take a look at the debt profile (a REIT’s debt profile can be found in their earnings presentations) of some of Singapore’s largest REITs like CapitaMall Trust (SGX: C38U) and Ascendas Real Estate Investment Trust (SGX: A17U), both REITs have diversified sources and terms of borrowings (they have revolving credit facilities, secured banking facilities, medium term notes etc.) and that could be a source of comfort for investors if the situation doesn’t change in the future.
Foolish Bottom Line
It’s not known yet if MAS’s proposed changes to the regulatory environment for REITs would happen. But if it does, and the aforementioned changes to the leverage limit does take place, investors might want to keep a close watch on their REIT’s leverage ratio and the diversity of its borrowings going forward.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any company mentioned.