In a move to enable Singapore real estate investment trusts (S-Reits) to better compete against private capital and foreign Reits when making real estate acquisitions, the Monetary Authority of Singapore (MAS) is considering raising their current leverage limit of 45 per cent.
Leverage, defined as the debt-to-asset ratio, measures how well-capitalised a company is.
The central bank on Tuesday published a consultation paper proposing amendments to the Code on Collective Investment Schemes, and invited the industry to give feedback on how the leverage limit can be recalibrated, among other things.
All written comments have to be submitted by Aug 1, 2019.
MAS said the move is aimed at providing S-Reits “with more flexibility to manage their capital structure and to streamline the fund-raising process for Reits”.
It noted that while the regulatory limit is at 45 per cent, Reits often try to maintain a 5 per cent buffer so that they are better able to respond to changing market conditions such as declining property prices. This leads to their generally keeping their leverage to within 40 per cent.
As at May 31, 2019, the sector’s gearing averaged 34 per cent.
Reit managers and sponsors have for some time now argued for higher leverage limits, partly also because debt tends to be a cheaper source of capital than equity and takes less time to raise.
MAS said: “This flexibility is particularly important when Reits acquire overseas assets from third parties, which has been the trend in recent years, driven partly by the search for assets with higher yield spreads. Unlike acquisitions from a Reit’s sponsor, such acquisitions tend to involve a competitive bidding process and are highly time-sensitive.”
The statistics show as much.
About 80 per cent of S-Reits and property trusts in Singapore own offshore assets, mostly in the Asia-Pacific, South Asia, North America and Europe.
In addition, regional competition is intensifying, with India being the latest market to successfully launch its first Reit, Embassy Office Parks Reit. Indonesia is working on its first Reit offering, DIRE Ciptadana. Other Asian jurisdictions that have recently been in the news about working on their respective Reit format include China and the Philippines.
MAS said one possible approach is to use a combination of leverage limit and minimum interest coverage requirement (ICR) in determining the amount of leverage Reits can take on.
The ICR measures a company’s debt-servicing ability.
Under this approach, Reits may take on higher leverage if they are able to meet a minimum ICR. This approach gives them more flexibility to optimise their capital structure when bidding for assets, with the minimum ICR serving as an additional safeguard. The minimum ICR will encourage Reits to assess their debt-servicing ability before taking on additional debt, it said.
MAS is considering allowing a Reit’s leverage to exceed 45 per cent but not more than 50 per cent, if the Reit has a minimum ICR of 2.5 times, after taking into account the interest payments arising from the new debt.
The central bank said: “The leverage limit is not considered to be breached if the Reit’s ICR subsequently falls below the ICR threshold due to circumstances beyond the control of the Reit manager. However, the Reit should not incur additional borrowings or enter into further deferred-payment arrangements.”
The regulator is also seeking views on whether it is appropriate for a Reit that has demonstrated good financial discipline, such as having a higher ICR threshold, to be allowed a higher leverage, say 55 per cent.
MAS also proposed requiring Reits to disclose both their leverage ratios and ICRs in interim-result announcements and annual reports, and to standardise the computation of the ICR for comparability across the sector.
At the Reit Association of Singapore’s annual conference on Tuesday, MAS executive director Abigail Ng said the industry has provided feedback that at the current leverage limit of 45 per cent, Reits face challenges when competing against other bidders such as private equity funds, property companies and foreign Reits. “These bidders often have more flexibility to use debt to optimise their capital structure,” she said.
The growth of private markets is accelerating. According to Bain & Company’s Global Private Equity Report 2019, private-market capital globally has grown at more than double the rate of public capital over the past 20 years, causing private market valuations to surge and businesses to stay private longer.
Like Singapore, Hong Kong imposes a leverage limit of 45 per cent on Reits; Malaysia imposes a 50 per cent limit. Thailand allows Reits to leverage up to 60 per cent if they have an investment-grade credit rating. Belgium, Germany and Netherlands have limits ranging from 60 per cent to 66.25 per cent.
Developed Reit markets such as the United States, Canada, Australia, France and Japan, on the other hand, do not impose leverage limits, and neither does the United Kingdom, although it requires Reits to maintain a minimum ICR of 1.25 times.
DBS Group Research analyst Derek Tan said raising Reits’ leverage limit could be a double-edged sword.
“While we acknowledge that it offers Reits more capacity to grow and improve their financial flexibility, we hope that Reit managers are experienced enough to know the dangers of the added gearing capacity at this point of the property market, after close to a decade of low interest rates, and not acquire too aggressively.”
Previously, S-Reits were allowed to borrow up to 35 per cent of their total assets; the limit could be bumped up to 60 per cent if the Reit obtains a credit rating from a ratings agency.
In 2015, MAS proposed to replace this with a single-tier leverage limit of 45 per cent. The Business Times understands that this was because it felt that a credit rating was not a good way of distinguishing a good-quality Reit from a poor one.
Separately on Tuesday, MAS proposed to streamline the fund-raising process for Reits by removing the requirement for them to submit a notification to MAS to obtain a “Restricted Scheme” status when they make an offer of units to accredited and other investors.
This will make the fund-raising process for Reits more efficient, and bring it in line with the fund-raising process for companies and business trusts, it said.