Credit investment implications from recent REITs and developers’ moves
Real estate investment trust (REIT) and property developers form a staple feature of the Singapore dollar (SGD) corporate credit market with $27.5 billion of bonds and perpetuals outstanding in total, representing around 26% of the market (excluding government bonds and statutory boards).
Given their significant prevalence and the earnings season is in full swing, we think it is an opportune time to share the key sector developments and implications to corporate credit investors.
REIT #1: Expect gradual rise in aggregate leverage
Amongst the REIT issuers that we track, the median aggregate leverage — broadly, the ratio of a REIT’s total debt to its total assets (including the portion of debt and assets held at joint ventures and associates) — is at 37.3% based on latest available data, which is an increase of 4.2 percentage points from 33.1% as of 2014. We expect aggregate leverage to gradually rise towards around 40% through acquisitions as issuers are increasingly comfortable with higher leverage.
The increase in aggregate leverage is partly driven by regulations as the limit was raised from 45% to 50% on April 16, 2020.
From Jan 1 this year onwards, REITs are also required to meet a minimum interest coverage ratio of 2.5 times before aggregate leverage can exceed 45%.
That said, the requirement is not difficult to meet as most REITs comfortably exceed 2.5 times interest coverage ratio with the exception of hospitality-focused REITs who are facing a challenging operating environment.
REIT #2: Watch out for acquisitions, combinations and mergers
Despite few underlying operational synergies among the different property asset types (for example, little cost savings from differing expertise needed), REITs in recent years are combining with other REITs with the rationale that “bigger is better”, typically affected through the bigger REIT buying the smaller REIT.
These includes the combination of (1) Frasers Logistics & Industrial Trust and Frasers Commercial Trust (renamed as Frasers Logistics & Commercial Trust), (2) CapitaLand Mall Trust and CapitaLand Commercial Trust (renamed as CapitaLand Integrated Commercial Trust), (3) Ascendas Hospitality Trust with Ascott Residence Trust, (4) Viva Industrial Trust with ESR-REIT (5) potential combination between Mapletree Commercial Trust and Mapletree North Asia Commercial Trust and (6) potential combination of ESR-REIT and ARA LOGOS Logistics Trust.
Bond prices may be impacted due to the changes in credit profile after the combination. In addition, the acquired REIT typically loses its listing status and gets subsumed as a subtrust without explicit guarantee from the new parent REIT.
Depending on the acquisition targets and funding structure, these may be detrimental to holders of bonds and perpetuals who do not have voting rights unlike shareholders. We think that more REITs may be in play, especially amongst smaller REITs as consolidation allows better access to funding markets. Investors of bonds and perpetuals should pay attention to the availability of covenants such as change of control and delisting puts, which can confer protection if not compensation against combinations.
REIT #3: Shifts in underlying profile with overseas acquisitions
Although Singapore assets still form the bulk of the asset base and income generation of Singapore REITs, 91% of all announced acquisitions amongst Singapore Exchange (SGX)-listed REITs by dollar value in 2021 were for assets located overseas.
Even though the investments are made mainly in developed markets, underlying operating drivers of property are highly localised with a differentiated risk profile in each geographical market. While we continue to track the office, retail and industrial property markets of Singapore, we expect the task of analysing Singapore REITs to become increasingly complex.
Developer #1: Record prices and transaction volumes support redemption of borrowings…
Residential property prices surged 10.6% yearon-year in 2021, breaking another all-time high record.
We expect property prices to increase by a further 5% to 7% in 2022, in spite of the property cooling measures, supported by aspirations of Singaporeans to upgrade and increasing household wealth which is rising faster
than housing prices. Meanwhile, supply is near multi-year lows with just 14,154 unsold units as of end-4Q2021, compared with around 13,000 transacted units in 2021 which is at multi-year highs.
With most buyers in the market being upgraders or first-time home buyers, we expect the recent property cooling measures, which are aimed at taming demand from those purchasing property for investment rather than owner-occupiers, to have limited impact on the housing market. We think developers should remain confident in moving most of the remaining unsold units and hence obtain the liquidity upon completion to return the loans and borrowings that were taken to finance the development.
Developer #2: …however record prices do not translate into record profits
While revenues have increased, expenses have increased faster. Developer margins are expected to compress as cost of tender has surged by around 20% since pre-pandemic, fuelled by steep rise in material costs and labour costs. The longer time taken to complete construction due to shortage of labour and pandemic measures like safe distancing also impacts the rate of return.
Meanwhile, land prices have also risen, with development charge rates increasing 9.3% since pre-pandemic, taking the cumulative increase since March 2016 to 66.4%. Credit profiles will be somewhat impacted from declining profitability, though we are not overly worried about developers defaulting on bonds as long as unsold units can still be moved and liquidity can be obtained.
Developer #3: Transitioning to other assets and geographies
As development of properties in Singapore is no longer lucrative, a number of developers have stopped tendering of land — noticeable absentees at land bids include CapitaLand Development, Frasers Property and Oxley Holdings. Capital has been diverted to other assets and geographies. For Oxley, it intends to focus on developing properties in the UK and Ireland where profit margins are higher. Frasers Property has increasingly pivoted to developing and acquiring industrial properties in Europe and Australia.
Meanwhile, CapitaLand Development has been acquiring and developing new economy assets (like data centres, business parks and logistics) as well as longer-stay lodging (like purpose-built student accommodation and rental housing). Similar to REITs who acquire properties overseas, the business and credit profiles of developers will become increasingly differentiated.
Positioning in a state of flux
Despite the evolving risk profiles of developers and REITs, we remain comfortable with most of the issuers under our coverage. Although the steep increase in rates has seen selling pressure on bonds since late 2021, this has uncovered some value as we upgraded the recommendations of 22 bonds, as opposed to lowering the recommendations of 14 bonds earlier this month.
We continue to favour selected perpetuals which may hold up better amidst higher rates, while their higher distribution may mitigate negative price return.
Ezien Hoo and Wong Hong Wei are credit research analysts focusing on corporate credit markets at OCBC Bank’s Global Treasury Research and Strategy team