The debt profile of a real estate investment trust (REIT) is a key determinant of whether it has the financial muscle to withstand interest rate hikes or to expand its portfolio through acquisitions. A REIT that has prudently managed its debt is more likely to be able to expand and increase unitholder returns in the future. Because of that, the debt profile is also one of the key aspects of the REIT that I assess. A REIT with poorly managed debt is a major red flag in my books, while one that has a track record of proper debt management…
The debt profile of a real estate investment trust (REIT) is a key determinant of whether it has the financial muscle to withstand interest rate hikes or to expand its portfolio through acquisitions. A REIT that has prudently managed its debt is more likely to be able to expand and increase unitholder returns in the future. Because of that, the debt profile is also one of the key aspects of the REIT that I assess. A REIT with poorly managed debt is a major red flag in my books, while one that has a track record of proper debt management is a major plus point.
So, how do I determine if a REIT has managed its debt profile prudently?
The gearing ratio refers to ratio of a company’s level of debt compared to its total assets. A REIT will typically release its gearing ratio levels on a quarterly basis in its quarterly report. We can also calculate the gearing ratio manually by dividing the REIT’s total borrowings from the total value of its assets.
Let’s take a real-life example from First Real Estate Investment Trust (SGX: AW9U), a healthcare REIT listed in Singapore. As at 31 December 2017, First REIT had total assets valued at S$1.42 billion and had total debt of S$478.6 million. By dividing the total debt by the total assets, we can calculate that the gearing ratio stands at 33.6%.
There is a regulatory gearing ceiling of 45%. As such, from the above, we can see that First REIT’s gearing ratio is well within the regulatory limit and it has the debt headroom for growth.
Cost of debt
The cost of debt is another important consideration when assessing the debt profile of a REIT. The cost of debt refers to the interest rate that the REIT has to pay each year to its creditors.
When assessing a REIT’s cost of debt, it is important not to look at it in isolation. The cost of debt can vary from REIT to REIT because of various factors such as the location of credit facility, length to maturity and other hedging costs.
It is also important to compare the cost of debt with similar REITs to get a better idea of where they stand. Investors should also take the time to work out whether the REIT’s cost of debt makes sense in comparison with the yield on its properties. Its properties should typically yield a higher rental income than its cost of borrowing.
Interest coverage ratio
The interest coverage ratio is used to determine how easily a REIT can pay its interest expenses. It is calculated by dividing a REIT’s net property income by its interest or finance expenses.
As you may have guessed, the interest coverage ratio is intricately related to the cost of debt. REITs that are able to keep its cost of debt low in comparison with its property yield usually have a higher interest coverage ratio.
I consider an interest coverage ratio above five to be very safe.
The Foolish bottom line
I have looked at three aspects of the debt profile when I assess a REIT. However, there are other aspects to look at. In another article, I will highlight another three factors of a REIT’s debt profile that investors should look out for.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended units of First REIT. Motley Fool Singapore contributor Jeremy Chia does not own shares in any companies mentioned.