A Possible Rights Issuance for REITs?

Singaporean retail investors have always liked investing in REITs, especially how it allows us to achieve a passive income from it. However, in the recent Novel-Global Recession, REITs have not been spared as well and for good reasons as we would discuss later in the article.

Looking at the table below, we can see how the share price of various REITs listed in Singapore has fared YTD. This is by no means the full list of REITs listed on SGX but just a snapshot to give you an idea of how returns on REITs have fared this year. Additionally, one would realise that the hospitality / commercial / retail REITs have fared the worst given how these sectors have been worst hit by the COVID-19 virus.

What has happened?

The COVID-19 virus has been especially disruptive to retail and hospitality operations, given how people are not only not wanting to go out in fear of contracting the virus but the Government is also discouraging people from heading out. As of Friday last week, the Government has announced that all non-essential services be stopped – meaning to say all shopping malls except restaurants will have to be closed. Employees are also advised to be working from home rather than heading to the office.

Furthermore, we see risks escalating for the REITs as a new bill is being passed by the Ministry of Law in Singapore, allowing tenants of non-residential leases to suspend rental payments to their landlords for approximately 6 months or more. Office REITs will too be affected, and we do see signs of it happening where WeWork is asking for a 30% cut in rental from their landlords. This is quite significant as co-working spaces has been taking up 30-40% of demand over the last few years, with WeWork being the biggest player.

Risks going forward

In Singapore, REITs have to comply with a leverage limit of 45% (Debt/Total Assets). Several REITs such as ESR REIT, OUE Commercial REIT and Cache Logistics Trust are above 40%. In normal circumstances, this would be fine as asset values are fairly stable and the REITs are below their leverage limit of 45%.

However, during such difficult times, a potential asset devaluation can result in such REITs breaching their leverage limit of 45%.

As seen from the table above, a REIT with Debt/Assets of 40% would only require a 11% drop in asset value to trigger the debt limit of 45%. I have done the calculations for the other permutations for REITs with different Debt/Asset and how much the asset can decline by before it hits the debt limit. Of course, REITs with a lower Debt/Asset would have more buffer before they hit the debt limit.

During the 2008/09 Global Financial Crisis, property indexes showed that office/industrial asset prices fell 20-24% and retail assets falling 13%. However, I do have to share that the indexes would include lower grade buildings. Another thing to note would that that MAS is currently considering whether to increase the debt limit to 50-55% as well.

What happens if the REIT surpasses the debt limit of 45%?

When investing, I always like to be prepared for the worst case scenario.

Hence, what happens if asset values do decline to a point where the debt limit of 45% is surpassed?

In such a scenario, REITs would have to do a rights issuance to raise equity capital so as to reduce their debt levels to fulfil with regulatory requirements. REITs whose debt levels are close to the regulatory limits may also consider conducting a rights issuance to shore up their balance sheet.

During the 2008/09 Global Financial Crisis, this actually did happen. Using CapitaMall Trust as an example, they announced a rights issuance of 9 rights for every 10 existing shares at the rights issue price of S$0.82. The reason for doing this rights issuance as mentioned by the company was to “…allow CMT to strengthen its balance sheet and reduce the CMT Group’s Aggregate Leverage from 43.2% as at 31 December 2008 to 29.1%…”

Conclusion

I will be sharing the list of REITs listed in Singapore and their current debt levels to my subscribers. Investors interested in getting their hands on this list would just need to fill up their details in the google sheet below!

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While I may be painting a very grim picture for REITs, what I mentioned may never actually come to happen. However, in investing I do feel you can’t predict but you can prepare. Knowing what is the worst case scenario and being mentally prepared that when investing, there might be a chance of a rights issuance is better than when it happens, it catches you off-guard. Additionally, for those invested in REITs whose debt levels above 40%, a rights issuance might be something quite probable.