You will be able to judge how much debt a REIT carries and how exposed it is to rate rises.
When interest rates rose sharply in recent years, many S-REIT unitholders watched rental income hold up while distributions fell, because a growing share of that income went to the banks. Darren's REIT went through exactly this. Its occupancy barely changed, yet his DPU dropped for two years running, and the results presentations kept mentioning higher financing costs.
A bank deciding whether to lend to a REIT asks three questions: how much it already owes, how easily it can pay the interest, and when its loans fall due. This lesson teaches you to ask the same three.
Gearing is a REIT's total borrowings divided by its total assets. MAS calls the regulatory version the aggregate leverage, and its definition in the Code on Collective Investment Schemes also includes certain deferred payments. The REIT reports the figure in its results.
With made-up figures, a REIT with S$1.6 billion of borrowings and S$4.0 billion of total assets has gearing of 40%.
Higher gearing means more of the REIT's assets are funded by lenders and less by unitholders. That makes the REIT more sensitive to two things: interest costs, because more debt means more interest, and falls in property values. If property values fall, total assets shrink and gearing rises, even without any new borrowing.
MAS sets the regulatory limit on gearing. You looked it up in lesson 4.4, How MAS regulates S-REITs. Compare the REIT's figure with that limit to see how much room it has.
The interest coverage ratio, ICR, measures how many times a REIT's earnings cover its interest bill. MAS defines it in the Code as earnings before interest, tax, depreciation and amortisation over the last twelve months, with certain items such as fair value changes left out, divided by the interest expense and borrowing-related fees over the same period. REITs report the figure in their results.
With made-up figures, a REIT with S$180 million of such earnings and S$50 million of interest expense has an ICR of 3.6 times.
Gearing describes the balance sheet, while ICR describes the cash that comes in each year. A REIT with expensive debt can have moderate gearing and still thin coverage, and one that borrowed cheaply can carry high gearing with coverage to spare, which is why you read the two together. MAS sets a minimum ICR too, and it is linked to the gearing limit, so check the current rule in the Code.
Gearing and ICR are snapshots. The debt profile tells you how they are likely to change. Results presentations usually include a slide on it. Look for three things.
The first is the share of debt at fixed rates. Fixed-rate debt, or floating debt fixed through interest rate swaps, keeps costs steady when rates rise. Floating-rate debt moves with the market.
With the made-up REIT above, say 70% of its S$1.6 billion is fixed, so S$480 million floats. If floating rates rise by one percentage point, interest rises by about S$4.8 million a year, to S$54.8 million. If earnings stay the same, ICR falls from 3.6 to about 3.3 times.
The second is the average cost of debt, the blended interest rate across all the REIT's loans. Compare it with what new loans cost today. If the average is well below current rates, the cost will rise as old loans are refinanced.
The third is the maturity profile: how much debt falls due each year. A large amount due in the next year or two means the REIT must refinance soon, at whatever rate the market then offers. That is what happened to Darren's REIT: cheap loans taken out years earlier came due and were refinanced at much higher rates.
A REIT close to its gearing limit or its minimum ICR has less room to borrow. If it wants to buy a property, it must raise more equity. If property values fall, it may be pushed over the limit and have to cut debt quickly, through a rights issue, a placement or an asset sale, often at a bad time and price.
That is why lesson 3.2, Warning signs that a dividend is about to be cut, listed debt near its limits as a warning sign, and why module 7 starts from equity raisings.
The latest results presentation is usually the quickest source. Most S-REITs put gearing, ICR, fixed-rate share, average cost of debt, weighted average debt maturity and a bar chart of maturities on one or two slides. The annual report has the full detail in the notes on borrowings.
In the activity you will pull those figures for one S-REIT, including how much debt falls due in the next two years, which is the number that tells you how soon its interest bill could change.
From one S-REIT's latest results, record gearing, interest coverage, fixed rate share, average cost of debt and the debt maturity in the next two years.
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