Judge what overseas assets add to a REIT's risk and return.
When an S-REIT owns property outside Singapore, its DPU depends on more than the rent its buildings earn. Exchange rates, hedging, local laws, local property cycles and overseas tax all affect how much of that rent reaches you.
Darren keeps a watchlist of REITs. One of them reported higher rent in every one of its markets for the year, but its DPU went down. He read the results twice before he found the cause, foreign exchange, in a line near the bottom of a slide. The rent had risen in the local currencies, but after it was converted into Singapore dollars there was less of it.
Many S-REITs own property outside Singapore, some partly and some entirely. Singapore is a small market, so a REIT can only buy a limited number of local malls, offices and warehouses. Overseas assets let it grow beyond the size of the local market, give it access to property types that are scarce in Singapore, and spread its income across several economies.
Overseas rent is earned in the local currency, such as Australian dollars, US dollars, euros, yen or pounds. Distributions are paid in Singapore dollars, or in some cases in another currency the REIT reports in, so the money is converted somewhere between the tenant and you. If the foreign currency weakens against the Singapore dollar, the same rent converts into fewer Singapore dollars, and if the foreign currency strengthens, distributions go up.
Take a REIT with A$50 million of distributable income a year from its Australian properties (these are made-up figures). At 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 is worth S$40.5 million. A 10% fall in the currency removes 10% of that part of the income, with no change at all in the properties.
Over long periods, currency moves can partly cancel out. But distributions are paid every quarter or half year, and in a single year a currency move can be big enough to wipe out a year of rent growth, which is what happened to the REIT on Darren's watchlist.
Most REITs with overseas income hedge part of their currency risk. Hedging here means fixing the exchange rate in advance for a share of the income expected to be distributed, usually over roughly the next year. The common tool is forward contracts, which lock in the rate ahead of time. A second method is to borrow in the foreign currency so that the property and its debt are in the same currency, which reduces the effect of currency moves on the balance sheet.
Go back to the Australian example. 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 that income falls about 3% instead of 10%.
Hedging smooths swings only for a limited time. Hedges expire and are replaced at the market rate of the day, so if a currency stays weak, the lower rate eventually feeds through. Hedging also has a cost, which depends on the interest rate gap between the two currencies.
Every REIT with overseas income states its hedging policy in its annual report, usually in the capital management or risk management section. The results presentation often shows the hedging on a slide too. In either place, look for the share of expected distributions that is hedged and how far ahead the hedges run.
Currency is the most visible overseas risk, but there are others. Landlord and tenant laws differ by country, and so do lease terms, how rents are reviewed, how easy it is to remove a tenant, and who pays which costs.
Property markets also run on their own cycles. For example, office demand can fall in one city while it rises in another. This spreads risk, but it also means you need some knowledge of each market the REIT is in, or should at least read the manager's comments on each one.
Overseas income may be taxed in the country where it is earned before it reaches the S-REIT. That can be corporate tax, withholding tax on payments out of the country, or both. Which ones apply depends on the country and on how the REIT holds the property, and the REIT's structure and any tax treaties affect how much is paid. Lesson 4.2, The payout rule and tax transparency, explained how IRAS treats S-REIT income at the Singapore end. That treatment does not undo tax already paid overseas, so two REITs earning the same rent from foreign properties can pay different distributions because of tax paid along the way. The taxation notes in the annual report explain which of these taxes apply to a particular REIT.
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, which is in the capital management section. To check a REIT:
Find the share of income by country in the REIT's results. Find the share of expected distributions hedged into Singapore dollars, and for how long ahead, in the capital management or risk management section of the annual report or on a slide in the results presentation. Read the annual report's taxation notes to see what overseas tax applies. Read the manager's comments on each market the REIT is in.
In the activity you will record both figures for one S-REIT with overseas assets, which will show you how much of its DPU depends on exchange rates in the year ahead.
Pick one S-REIT with overseas assets and write down its share of income from each country and the share of distributions hedged into SGD.
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