Real Estate Investment Trusts (REITs) are considered by many to be a safe-haven asset class due to their relatively stable rental income and debt-to-asset ceiling of 45%. However, it seems that REITs are still susceptible to steep drawdowns just as much as other stocks.
The REIT market in Singapore has been hammered as badly as the Straits Times Index, if not worse, over the past few days.
The table below shows the price changes of some of the REITs in Singapore since 9 March 2020. Even REITs backed by traditionally strong sponsors such as Mapletree Investments Pte Ltd and CapitaLand Ltd have not been spared.
Why?
In my mind, the likely reason why REITs have been hammered so badly recently is that investors are worried that REITs’ tenants will not be able to pay their committed leases.
Loss of revenue could potentially bankrupt businesses causing them to default on their rent.
REITs, in turn, will then face lower rental income in the coming months. This leads to a vicious cycle, where the REITs are then not able to service their interest expenses and may need to liquidate assets or raise capital in this extremely harsh environment.
Worried investors have been scared off from REITs during these difficult times and have flocked to “real” safe-haven assets such as treasuries and US dollars.
What now?
I think this is a perfect time for investors to take a step back to reassess their portfolio. It is important to know which REITs in your portfolio can weather a storm and which are at risk of a liquidity crisis.
The share price of a REIT may not be truly reflective of its ability to weather the storm. Some REITs that have been sold off hard may actually have the means to run the course, while others that have yet to be sold down may end up having to raise more capital. So I am more interested in the fundamentals of the REIT, rather than the price action.
What I am looking out for
In these unprecedented times, here are some things I look for in my REITs:
1. Stable and reliable tenants
If tenants can pay and renew their rents, REITs will have no trouble in these difficult times. For instance, REITs that have government entities as tenants are safer than REITs that have small and highly leveraged companies as tenants. Elite Commercial REIT (SGX: MXNU) is an example of a REIT with a stable tenant. The UK government is its main tenant and contributes more than 99% of its rental income.
2. A diversified tenant base
In addition to the first point, REITs that have a highly diversified tenant base are more likely to survive. For instance, malls and office building owners whose buildings are multi-tenanted are likely to be less susceptible to a sudden plunge in rental income should any tenant default. Mapletree Commercial Trust (SGX: N2IU) and CapitaLand Mall Trust (SGX: C38U) have multiple tenants and are less susceptible to a collapse in net property income.
3. Low interest expense and high interest-coverage ratio
REITs such as Parkway Life REIT (SGX: C2PU) are more likely able to service its debt as its interest expense is much lower than its earnings. At the end of 2019, Parkway Life REIT had a high interest-coverage ratio of 14.1. So Parkway Life REIT should be able to service its debt even if there is a fall in earnings.
4. Low gearing
A low debt-to-asset ratio is important in these tumultuous times. REITs that have low gearing can borrow more to tide them through this rough patch. REITs such as Sasseur REIT (SGX: CRPU) and SPH REIT (SGX: SK6U) boast gearing ratios of below 30%.
Don’t Panic…
The last thing you want to do now is panic. In a time like this, is important to stay sharp and not do anything rash that can hurt your portfolio.
Breathe. Take a step back and reassess your positions. Don’t focus too much on the price of a REIT. Instead, focus on its business fundamentals and whether it can survive this difficult period. If so, then the REIT will likely rebound when this COVID-19 fear finally settles.
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Hello SJ
Great Article on REITs at this moment in time!! From your personal opinion, which of the current reits you think are safe and higher potential for growth?
Best Regards, BL
Hello BL!
Jeremy wrote this article =)
I think the Mapletree entities are the best-run REITs in Singapore. Parkway Life REIT with its low interest-rate-debt and resilient properties (hospitals!) looks well-positioned too.
Cheers,
Ser Jing
If you are worried about the impact of tenant default, then you should probably read the DBS Paper released on March 20th that indicates in relatively low levels of occupancy decline during the GFC (except hospitality), all of which bounced back relatively quickly.
Reits will be unlikely to want to /or able to liquidate property assets – and the banks will be reluctant to foreclose (as they will not want the non-core assets on their books’) – Reits still have a strong underlying asset ie physical property.
If you look at the pattern of sell down, it could imply that there were high levels of margin traded accounts – not surprising given the run up that S-Reits have had in the past year. So some people have been quite badly hurt by the sudden sell off
Low interest rate expense (with the Fed cut) is now marginal impact IMHO on the operations. I do agree gearing will be something to look at carefully- I’ve not seen a re-pricing yet on revised NAV which will be coming shortly presumably, but could be substantial.
Hi John,
Totally agree. The steep sell down could possibly be due to margin calls from leveraged accounts. REITs, in particular, have been hit hard as investors leveraged up on REITs as they assumed REITs are relatively stable instruments.
Hopefully, S-REITs don’t face too many tenancy defaults. Looking forward to the next earnings results to get a better picture.
Lots of PB clients playing the trade where you borrow at 2.5% and invest in REITs at 5%.
Good buying opportunity for some of the more stable ones like Parkway Life, Netlink Trust, imo… not too sure about the retail, industrial and hospitality ones…