You will be able to judge what overseas assets add to a REIT's risk and return.
Darren noticed that one of the REITs on his watchlist had reported higher rent in every one of its markets for the year, and a lower DPU. He read the results twice before he found the line that explained it, near the bottom of a slide: foreign exchange. The rent had gone up in the local currencies. By the time it was turned into Singapore dollars, there was less of it.
Many S-REITs own property outside Singapore, and that brings its own set of things to check.
Singapore is a small market, and there are only so many malls, offices and warehouses a REIT can buy here. Many S-REITs own properties in other countries, some partly and some entirely. Overseas assets let a REIT grow beyond the size of the local market, buy property types that are scarce in Singapore, and spread income across economies.
The rent from those properties is earned in the local currency: Australian dollars, US dollars, euros, yen, pounds and others. Your distributions, though, are paid in Singapore dollars, or in some cases in another currency the REIT reports in. Somewhere between the tenant and you, that money gets converted.
When the foreign currency weakens against the Singapore dollar, the same rent converts into fewer Singapore dollars.
With made-up figures, an S-REIT earns A$50 million of distributable income a year from Australian properties. At an exchange rate of S$0.90 per Australian dollar, that is S$45 million. If the Australian dollar falls to S$0.81, the same A$50 million becomes S$40.5 million. A 10% fall in the currency takes 10% off that part of the income, with no change in the properties at all.
The reverse also happens: a stronger foreign currency lifts distributions. Over long periods the moves can partly cancel out, but distributions are paid every quarter or half year, and in any given year the currency can move enough to wipe out a year of rent growth. That is what Darren had seen.
Most REITs with overseas income hedge some of their currency risk. A common approach is to fix, in advance, the exchange rate for a share of the income they expect to distribute over the next year or so, using forward contracts. Some also borrow in the foreign currency, so that the property and the debt against it are in the same currency, which reduces the effect of currency moves on the balance sheet.
With the made-up figures above, say the REIT has hedged 70% of its expected Australian distributions at S$0.90. When the Australian dollar falls 10%, only the unhedged 30% is affected, so the hit to that income is about 3%, not 10%.
Hedging smooths the swings, but only for a time. Hedges expire and are replaced at whatever rate the market then offers. If a currency stays weak, the lower rate eventually works through. Hedging also costs something, depending on the interest rate gap between the two currencies.
Every REIT with overseas income states its hedging policy in the annual report, usually in the section on capital management or risk management. Look for the share of expected distributions hedged and for how long ahead. The results presentation often shows it on a slide.
Currency is the most visible risk, but not the only one. Foreign property comes with different landlord and tenant laws. Lease terms, how rents are reviewed, how easy it is to remove a tenant and who pays which costs all vary by country.
Property markets also move on their own cycles. Office demand in one city can be falling while another's is rising. That can help spread risk, but it also means you need to know something about each market the REIT is in, or at least read what the manager says about it.
Tax is the third difference. Overseas income may be taxed in the country where it is earned, before it reaches the S-REIT. Depending on the country and how the REIT holds the property, there may be corporate tax, withholding tax on payments out of the country, or both. The REIT's structure and any tax treaties affect how much.
Lesson 4.2, The payout rule and tax transparency, explained how IRAS treats S-REIT income at the Singapore end. That treatment does not reverse tax already paid overseas. So two REITs with the same rent from foreign properties can pay different distributions because of tax along the way. The annual report notes on taxation explain what applies.
For any S-REIT with overseas assets, two figures tell you most of what you need. The first is the share of income by country, which most REITs report in their results. The second is the share of expected distributions hedged into Singapore dollars, from the capital management section.
In the activity you will record both for one S-REIT with overseas assets, which will show you how much of its DPU depends on exchange rates in the year ahead.
For one S-REIT with overseas assets, record the share of income by country and the share of distributions hedged into SGD.
Junxiong-WFG Organisation is an authorised representative of AIA Financial Advisers Private Limited (Reg. No. 201715016G).