REITs - RHB Invest 2019-07-04: Proposal To Lift Gearing Limit; OVERWEIGHT

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REITs - Proposal To Lift Gearing Limit; OVERWEIGHT

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MAS move to review gearing limit a positive step. MAS has published consultation paper, which will look at reviewing the S-REITs’ current gearing limit (from 45% to c.55%), and remove notification requirements. We see this move as timely considering S-REITs’ strong growth from overseas REIT listings, and expansion of local players in overseas markets.

Average S-REIT gearing stands at 35% with interest coverage ratio (ICR) of 5.6x as at 2018. While gearing limit stands at 45%, REIT managers in general tend not to exceed 40% to buffer for unforeseen circumstances.
Only one of 41 S-REITs has gearing > 40% - ESR-REIT (SGX:J91U).

In our view, the proposed move, if implemented, is likely to result in S-REITs moving their internal gearing threshold from 40% to 45%, which is still in line with current regulations. Key benefits would be cheaper cost of capital (low interest rates), and additional debt headroom for portfolio growth.
More importantly, the higher gearing should also allow S-REITs to better compete with other fund types (which have a more flexible capital structure) for acquisitions.
The Monetary Authority of Singapore (MAS) also noted that S-REITs’ current gearing limit is on the lower end compared to key REIT markets like Hong Kong (45%), Malaysia (50%), Thailand (60% with investment grade) while the US, Canada, France, and Japan do not impose a leverage limit.

The rise in gearing limit however increases portfolio risk, especially during severe market recessions (eg GFC), and should expose REITs to vagaries of debt markets (refinancing risks, fluctuations in interest costs etc). As proposed by MAS, one way of managing this risk is by having an additional criteria such as meeting the minimal ICR threshold of 2.5x, before allowing a higher gearing limit.
Other factors that could be taken into consideration in our view, are evaluating REIT managers’ track record over a period of time (eg DPU/NAV growth), and looking at the percentage of unencumbered assets.
Another possibility is for a REIT to put the proposal to increase its gearing limit during the annual EGM, and get shareholder approval. This, in our view, should allow REIT managers to explain their rationale and for unit holders to better evaluate market conditions and managerial capabilities.

With more REITs using perpetual securities as an additional funding source, it will also timely to review and introduce guidelines in terms of perpetual securities usage (eg caps as percentage of total equity), and the accounting treatment.
See attached PDF report for S-REITs peer comparison table.

Vijay Natarajan RHB Securities Research | https://www.rhbinvest.com.sg/ 2019-07-04

SGX Stock Analyst Report BUY MAINTAIN BUY 0.830 SAME 0.830

BUY MAINTAIN BUY 0.960 SAME 0.960

BUY MAINTAIN BUY 1.770 SAME 1.770