Many REITs are not doing well and some are in trouble. These REITs have seen their value eroded significantly, likely to the point of no return.
REITs have been delivering lower distribution per unit to unitholders in the recent years. They have been impacted by higher interest rates, higher vacancies and may very well start to see negative rental reversions or rental reversions where positive do not keep up with the rate of inflation and its cost base.
Where these leads to is asset devaluations, putting the REIT’s sustainability into question.
Previously we wrote about the dark side of Chinese SREITs and answered the question on whether you should buy, hold or sell Manulife US REIT and other US REITs.
On both occasions, we explained what went wrong and in the latter we also concluded whether you should make a purchase. The answer was – No, we would not buy the dip.
Today, we provide a brief update on each REIT, identify commonalities and hopefully provide insights to REIT traps you should avoid.
3 REITs in Trouble
1) Manulife US REIT (SGX: BTOU)
On 14 Aug, MUST announced its 1H23 results. Gross revenue was relatively stable at a 0.8% decline while net property income declined a mere 3.9%.
This shows that despite the lowered valuation recorded, the REIT was still able to deliver relatively stable income.
Due to higher interest costs, distributable income declined 17.4%.
Unfortunately, distributions were halted due to the high gearing ratio of 57% leading to a breach of its financial covenant.
This was because of a 10.9% decline in valuation at the end of 2H22 and then another 14.6% decline in valuation at the end of 1H23.
2) Dasin Retail Trust (SGX: CEDU)
Dasin had most of its borrowings due and they were not able to refinance. Dasin has extended the borrowings by a couple of months each time in the past few years but has not been able to secure a long and stable facility.
Dasin tried to sell some of its assets back to one of its major unitholders but were not able to do so despite prolonged negotiation.
Should Dasin be able to sell these two assets which form 43% of its investment properties, it will likely be saved but be handicapped as these two assets are considered its prized properties.
3) EC World REIT (SGX: BWCU)
EC World REIT voluntarily suspended trading of its shares effective immediately on 31 Aug 2023, after being halted since the afternoon of 28 Aug. This was because EC World would not be able to fully repay offshore interest expenses due on 31 Aug.
EC World REIT has a substantial portion of its assets leased to its sponsor and the sponsor was not able to pay rental due on them.
Consequently, the REIT said that it could not meet its interest obligations unless its sponsor manages to pay a sufficient amount of the rent receivables within the given timeframe.
The rent receivables are spread across EC World’s four master-leased properties in China.
As more than 80% of the revenue of EC World comes from rental income pursuant to related party leases with the Sponsor, accordingly, if the sponsor does not pay a sufficient amount of the rent receivables going forward, EC World will be unable to maintain its operating and financing requirements.
Breaching this requirement would also trigger a cross-default under EC World’s existing onshore facilities and lead to relevant lenders accelerating the facilities, or in other words, demand repayment.
EC World REIT’s manager is further seeking an extension of time to top up the said offshore interest reserve and not to demand repayment.
Commonalities between REITs in Trouble
These three REITs mentioned all share a few commonalities such as:
- impending debt which they cannot refinance
- limitations in their attempt to refinance their debt.
As time goes by, their asset value naturally also decline due to lack of competitiveness and further erodes value.
Key takeaway: A REIT is not a basket of properties
One point many investors have missed is that a REIT is not merely a basket of properties.
While it is true that there are properties held under a REIT and the business model of renting may seem to be straight forward, in actual fact, a REIT is a much more complex.
i) REITs have to fulfill specific criteria & face restrictions
To qualify as a REIT, a company must comply with certain provisions such as the Monetary Authority of Singapore’s Property Funds Appendix which designates permissible investments as well as restrictions such as the well known aggregate leverage limit. It also specifies what can be done when the rules are breached.
The Inland Revenue Authority of Singapore also has a comprehensive set of requirements before a distribution of income can be regarded as tax transparent or tax free.
ii) REITs borrow money, and need to manage their debt
A REIT operates by borrowing from banks to purchase assets and therefore have to adhere to a slew of covenants imposed by banks such are interest coverage ratio and leverage ratios. Covenants are restrictions on the REITs and should any of these covenants be breached, limitations can be placed on the REITs.
Lenders may also place an encumbrance on the property such that the lender would have first priority to seize the property in the event the REIT is not able to repay its debt.
Common limitations include the inability to make distribution, borrow or spend. In many worst case scenarios, the debt also becomes due to be paid immediately.
When the REIT is not able to repay this debt, the REIT is considered to have defaulted on its obligations and the bank can either seize the properties that may have been mortgaged to the bank. The REIT can even be put into liquidation by the bank via a court process.
Not being able to spend on asset maintenance and enhancement initiatives is also an eventual death sentence as it slowly erodes the asset’s competitiveness.
REITs sounds so scary – can we still buy?
REITs offer several advantages not found in companies across other industries.
- A REIT has a substantial portion of recurring income as its income is derived from rents. In many sectors, tenants often sign leases for long periods of time.
- Most REITs operate along a straightforward and easily understandable business model which is attractive to investors.
- A REIT provides steady stream of income to investors through dividends. Because REITs are required to pay 90% of their annual income as shareholder dividends, they consistently offer some of the highest dividend yields in the stock market.
- The benefits of a REIT investment are that it is also fundamentally a purchase of a group of assets.
For investors who are keen on investing in the property market but want liquidity, diversification, and passive income in the form of high dividends, a REIT will provide all of this.
In short, REITs over time have demonstrated a historical track record providing a high level of current income combined with long-term share price appreciation, inflation protection, and prudent diversification for investors across the age and investment style spectrums.
For these benefits, the REIT have to fulfill specific criteria & face restrictions. The REIT structure is also leveraged and the REIT has to borrow and manage its debt.
Hence, we reiterate the lesson – a REIT is not a basket of properties but an acronym which stands for Real Estate Investment Trust and that comes with a whole set of risk that a basket of properties alone, does not have.
p.s. Chris shares how he picks the best REITs for his dividend portfolio that pays him regularly. If you’re unsure of how to pick safe REITs, join him at his next workshop to find out more.