The last 2 weeks have not been easy for Singapore REITs investors. S-REITs have been dropping almost everyday with unusual volatility and transaction volume. This happened even when global central banks have been cutting interest rates which have boosted S-REITs’ share prices in the past.
Investors are wondering what has happened that triggered the huge sell down and whether there are any bargain hunting on REITs. I will share my views in 5 key areas:
Year-to-date, the FTSE ST REIT Index was down 35%, which was performing worse than STI’s 31% drop. Some REITs have even dropped by close to 50% from the start of the year.
The drop in S-REITs prices is definitely due to the expectation of lower rental rates, lower occupancy rates and potential devaluation of underlying properties due to the impact of COVID-19.
Honestly the magnitude of drop is not as huge as that of the global financial crisis (GFC) yet as S-REITs prices dropped by close to 70% during GFC. Analysts are not expecting this 70% drop to be repeated as the financial metrics such as interest coverage and debt tenor have improved as compared to the GFC period. However, the speed of drop for the past 2 weeks were much faster than what most investors expected.
I am suspecting that this could be due to margin calls and force selling by investors who were using borrowing to finance their REITs investments. I do not have the data to support this hypothesis but it should be one of the main reasons for the sudden sell down on REITs.
#2 Gearing Ratio Limit
REITs have to comply with more rules compared to most other stocks. One of the rules is that the gearing ratio must not exceed 45%.
Gearing ratio is defined as debt-to-asset ratio. During this environment, the asset may devalue as the global economy deteriorate. With lower asset value, the gearing ratio will increase and may breach the 45% limit.
If this happens, REITs may have to raise capital from unit holders through a rights issue or a private placement at low subscription price (because the share price has declined significantly). These events would in turn dilute the holdings of existing investors who don’t participate.
However, this may not happen as Monetary Authority of Singapore (MAS) may raise the leverage limit to above 45% and the intention has been announced last year (you can read more about this here).
To help you with an estimation: if the current gearing ratio is at 37%, the asset value needs to devalue by 17.8% to hit the 45% limit.
Hence, REITs with higher gearing ratios would be more vulnerable during this crisis.
Breaking down into sectors, hospitality REITs did worst while healthcare REITs were less impacted. It shouldn’t be a surprise to you.
- Healthcare REITs: -26%
- Retail REITs: -31%
- Industrial REITs: -31%
- Commercial REITs: -35%
- Diversified REITs: -37%
- Hospitality REITs: -45%
Below is the table of the individual REITs and their performances:
Although REITs prices have dropped across all sectors, healthcare, industrial and retail REITs were less affected. The declines in occupancy rates for healthcare, industrial and retail properties during GFC were not as significant as the other sectors.
Possible reasons are that healthcare is a defensive industry and we have to seek medical care regardless of the state of the economy. Industrial properties are unique in terms of property structure and management while retail malls in suburban areas and at good locations tend to be able to find new tenants without much trouble.
Commercial REITs are very dependent on the economy and their own performances. As the offices are usually rented by big corporates, the rental reversion rates may not be favourable given the current economic climate. Covid-19 measures such as work from home scheme and hot desking have reduced occupancy rates for commercial properties.
Hospitality REITs definitely are the REITs that are the most severely and directly impacted. Travel restrictions of COVID – 19 should last for a prolonged period. The revenue from hospitality REITs are likely to show very ugly numbers in the coming quarters.
In terms of the country exposure, REITs with presence in China should show faster recovery where the COVID – 19 outbreak seems to be under control. There are several REITs who have announced the reopening of the malls and offices in China.
#4 Bargain Hunting
There are many REITs that are trading at low valuations at this moment. For REITs valuation, I will use Price-to-Book ratio (PB) and compare to its historical average. For dividend yield hunters, I will use current dividend yield and compare to the historical average.
Below is the full valuation analysis for Singapore REITs. The REIT with the most negative % is the one trading at the most undervalued price as compared to its historical average:
The above valuation table is purely based on numbers, you should perform qualitative assessments before buying any REIT. Some qualitative factors to think about (the list is not exhaustive):
- Financial strengh of the REIT sponsor
- Geographical exposure
- Weighted Avearage Lease Expiry (WALE) period
- Restructuing of the REIT in the past and potential restructuring in the future
- Debt Tenor
You can refer to our REITs Guide for more information.
#5 Leverage REITs Portfolio
Leverage REITs portfolio has been a hot topic recently. There are investors who use margin accounts to get positive carry from investing in REITs.
For example, if the REITs dividend yield is 6% and margin financing rate is 3%, the investors will get net 9% yield if the investor leverage with 2x capital. (2 x 6% – 3% = 9%).
The big issue with leverage investment is that it is subjected to margin call if the REIT prices drop to a certain level. You need to top up cash into your investment account if margin call happens, else you have to force to sell your holdings.
There are many different ways to build a leverage portfolio. One of the common methods is to use a margin account.
As most of the listed S-REITs are considered as grade A shares under margin accounts, investors can invest up to 3.5 times of the investment capital that they have in their margin accounts.
Based on margin calculation, if investor bought up to 3.5x, margin call will happen if the portfolio value drops by 7.14%.
If investor buy up to 2x, margin call will happen if the portfolio value drops by 35%.
My view is that while leverage helps to increase your potential return, it also amplifies your downside risk. You must be emotionally stable and be prepared if margin call happens. Also, with leverage portfolio, your portfolio volatility will be amplified as well.
Given the sudden drop in REITs prices, I believe there are some REITs that are worth to be accumulated.
Yes, we are definitely expecting some of the REITs will cut their dividends and devalue their properties, but I think the drop is exaggerated beyond business fundamentals. It could be due to margin calls and mispricing of the REITs.
Personally, I prefer REITs with China exposure and REITs in sectors such as healthcare, industrial, and retail with properties in suburban areas. I will also look out for REITs with strong sponsors. My approach currently is to diversify into various REITs in different sectors.
Disclosure: I am vested in some REITs and have the intention to accumulate more in the future. Please do your own due diligence before making any investment decision.