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Difficulty: Moderate
1) REITs aren’t necessarily defensive stocks, especially in a downturn
Singapore REIT (S-REIT) share prices fell 75% peak-to-trough during the 2007-09 financial crisis, relative to a 62% decline in the Straits Times Index (STI).
2) S-REIT sector valuations are still expensive, despite a 17% price decline this year
Key metrics, such as price-to-book ratios, dividend yields and dividend yield spreads over government bond yields all currently indicate that the sector is NOT trading cheap.
3) A key risk would be if S-REITs start to initiate rights issues to raise cash to pay down debt
There was very heavy S-REIT equity fund raising activity during the 2007-09 period to pay down debt. This fundraising activity came at the worst possible time, given that cash strapped investors who were unable to subscribe to the new shares had their stakes in the REITs diluted.
4) For the covid crisis, government relief measures for REITs will help in the short-term
Most importantly, the Monetary Authority of Singapore will raise the gearing limit for S-REITs from 45% to 50%, with immediate effect. That said, one should keep on eye on relatively highly geared REITs (list below).
5) IQ will be buying into the S-REIT sector at 15-20% below current price levels, implying price-to-book ratios of <0.8x
REITs are not as defensive as you think. The general perception of REITs is a vehicle that is tax efficient, defensive and provides a steady income stream. Such features have made it appealing to both budding investors as well as retirees. Would it then surprise you to find out that Singapore REITs fell by 75% during the 2007-09 financial crisis?
With the Singapore REIT market pulling back as much as 38% year to date, we have seen renewed interest in the sector from investors attempting to bottom fish. The key question is how attractive does the sector look now and have we reached a bottom?
Singapore REITs are not trading cheap
Singapore has a bustling REIT sector. Based on SGX’s monthly chartbook on REITs and Property Trusts (May edition), Singapore has a total of 44 REITs & Property Trusts with a combined market capitalisation of S$94 billion, representing c.12% of Singapore’s overall listed stocks. For purposes of this article, we will be using the FTSE ST REIT Index, which comprises 37 out of these 44 trusts, for our analysis.
Price to Book (P/B) valuations do not look cheap. REITs have to revalue their investment properties at least once per year, which directly impacts the REITs’ book values. Hence, P/B ratios are a good indicator of REIT valuations. With REITs trading at a P/B of 0.96x currently and in line with historical averages, this does not seem cheap, as we have to factor in that property book values will likely be adjusted downwards over the course of the next year or two.
The InvestQuest’s View: Given the current investment climate, I would personally average down into the REIT sector only when I see sector P/B ratios touching 0.8x and below.
Dividend yields are not attractive enough. At current trailing 12-month dividend yield of 5.1%, this is lower (more expensive) than 6.2%, the average yield since Dec-2007. It is also lower than 5.6%, the average yield since 2010 where we exclude the spike during the 2007-2009 crisis. With retail and hospitality sectors hit particularly hard, REIT sector dividend per unit (DPU) is unlikely to be sustained this year, implying that the 5.1% trailing 12-month dividend yield would also likely trend downward, assuming current share prices hold.
Dividend yield spread looks alright. Dividend yield spread = Dividend yield – 10-year Singapore government bond yield. The dividend yield spread is a measure of how much investors are getting in higher returns as compensation for buying REITs (a riskier asset) versus buying the SG government bond (almost risk-free asset). Despite the dividend yield being low, the dividend yield spread is currently at okay levels of 4.4% versus its historical average of 4.0%. The key reason for this is due to an unprecedented decline in Singapore’s 10-year government bond yields, which is now at 0.72%.
The last crisis precipitated equity fundraising, further worsening share price returns
The REIT sector sell off was much more severe during 2007-09, compared to the one we just experienced. This is most evident when we look at the peak-to-trough price declines of the same REITs over both periods in the tables below.
Why was the price decline so bad? We believe it was because of equity fundraising (rights issues and placements) during 2007-2009.
Why were REITs doing placements and rights issues in 2007-2009? With the economic recession, property asset values were being valued lower. This was then reflected on the REIT’s balance sheet annually. Because the REIT’s asset value decreased, gearing ratios increased even without the REIT taking on more debt. (The gearing ratio, aka the leverage ratio, is the debt amount divided by assets). In some cases, some REITs were getting uncomfortably close to the regulatory gearing limits. At that time, the Monetary Authority of Singapore’s gearing limit was 35% for unrated REITs and 60% for REITs with credit ratings.
To avoid breaching the limit, several REITs executed rights issues and/or placements to reduce their gearing. They used the cash raised to pay down their debt.
Example of how gearing can breach 60% limit. Recall, the gearing ratio is REIT’s debt divided by assets. Assume a REIT has $50 of debt and $100 of assets, implying a gearing ratio of 50%. If property values are decreased by $20, while $50 debt levels remain constant, the gearing would now be 62.5% ($50 / $80).
Example of how a rights issue can lower the gearing. Continuing the above example, the REIT conducts a rights issue. In essence, it is asking its existing shareholders to pay more money to maintain the same ownership stake in the REIT (e.g. 0.00001% for Shareholder A, 0.003% for Shareholder B, etc.). In return, the REIT should theoretically be worth more after the rights issue. Let’s say the REIT raises $10 through the rights issue. The REIT can then use $10 cash raised to pay back their debt. Debt decreases from $50 to $40 and the gearing is now 50% ($40/$80).
Examples of REIT equity fundraising activities in 2007-09, with intentions to reduce gearing using cash raised. Capitaland Mall Trust stands out the most, raising S$1.58 bn with the sole intention to pay down debt using raised proceeds.
Equity fundraising came at the worst possible time. The equity fundraising timeline is overlaid with the FTSE ST REIT Index in the below chart, showing that bulk of the fund raising was done at the worst possible time when markets were bottoming…imagine being asked to cough out more cash when you are already facing margin calls elsewhere. Shareholders who chose not to or were already too financially stretched to subscribe to the rights issues ended up having their ownership stakes diluted and missed out on the subsequent rally.
For the current crisis, regulators have been taking some preemptive measures to reduce the chances of such a scenario from happening again.
Government relief measures for REITs will help in the short-term
To help REITs to navigate the Covid-19 crisis, the Singapore government has stepped in with some relief measures for the sector. This includes:
- Easing REIT cash flow concerns by extending the timeline for S-REITs to distribute at least 90% of their taxable income from 3 months to 12 months, applicable for distributions made from taxable income that is derived by an S-REIT during FY2020.
- Easing gearing limits. MAS will raise with immediate effect the gearing limit for S-REITs from 45% to 50%.
- Easing gearing limit requirements. MAS will defer to 1 January 2022 the implementation of a new minimum interest coverage ratio (ICR) requirement. MAS had proposed to require S-REITs to have a minimum ICR of 2.5 times before they are allowed to increase their leverage to beyond the prevailing 45% limit (up to 50%)
The easing of gearing limit requirements is especially important for REITs that are operating at the high-30% to low-40% gearing ratios currently. This is because if and when investment property values are revalued downwards, there is a chance that these REITs will breach the 45% gearing limit (which has now been raised up to 50%).
That said, it is still important to keep an eye on highly geared REITs. Here are REITs with gearing levels of 39% and above (as of 31 March 2020) according to their SGX announcements:
- Lippo Malls Indo Retail Trust – 42.1%
- ESR-REIT — 41.7%
- ARA Logos Logistics Trust — 40.8%
- OUE Commercial Trust — 40.2%
- Far East Hospitality Trust –39.5%
- Mapletree North Asia Commercial Trust — 39.3%
- Mapletree Logistics Trust — 39.3%
The InvestQuest’s View: In conclusion, I wouldn’t be adding into S-REITs at current levels, especially after the sector has rebounded 24% from the March troughs. Across various metrics such as P/B, dividend yields, and dividend yield spreads over govt bond yields are all pointing to the sector being fairly valued to outright expensive, given the current circumstances.
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