About two decades after the Singapore REITs market started in 2002, there are today over 35 S-REITs and Trusts with a total market capitalisation of more than $100 billion.
Making up around 15% of the Singapore Exchange’s total market capitalisation, these instruments are no longer just an essential component of the Singapore stock market but also its bright spot, recording a total return of 53% over the past five years.
The capital structure of a REIT can consist of equity, perpetual securities and bonds. REIT bonds and REIT perpetual securities have become increasingly common as REITs diversify their sources of funds beyond equity, in part to fund acquisition opportunities.
REIT bonds are debt instruments and REIT bondholders are essentially creditors to the REIT. The REIT is legally obligated to repay the creditor the borrowed sum in full at a future date and compensate the creditor for bearing the risk over the term of the debt through a fixed interest payment.
Explore beyond REIT equity
In essence, the REIT bondholders’ return (should they hold the bond to maturity) is capped. Irrespective of the price fluctuation of the bond throughout its life and assuming no default, the REIT bondholder will be paid the face value of the bond at maturity.
Meanwhile, REIT perpetual securities are hybrid instruments with features of both bonds (like pay coupons) and equity (one that has no maturity date). Both bonds and perpetual securities typically come with covenants — terms of agreement between the issuer and the bondholder — which safeguard the interest of bondholders.
A typical Singapore dollar REIT perpetual security has the following features. First, REIT perpetual securities are subordinated. Second, while they typically reset every five years, there is no step-up (which offers economic incentive for issuers to redeem perpetual security at its call date). Third, even though REIT perpetual securities can defer distributions on a non-cumulative and non-compounding basis, the dividend stopper covenant is applicable.
This covenant requires REITs to pay coupons to perpetual security holders so long as dividends are paid to equity holders. REITs are exempted from tax payment if at least 90% of the taxable income is distributed. This helps mitigate non-payment of perpetual distribution given that REITs typically pay out dividends to equity holders.
The key difference among the three financial instruments is the order of seniority, or the order of repayment in the event of a sale or bankruptcy.
Equity is the most junior, while bonds are the most senior. REIT perpetual securities, which are subordinated instruments, rank more senior than equity, but are junior to bonds.
How do they stack against one another?
Intuitively, the lower the risk, the lower the return that investors expect. As such, we would expect equity to return more than perpetuals, and perpetuals to return more than bonds. However, in practice, this may not always hold especially in the short- to medium-term.
Unlike the fixed coupon payment on bonds and perpetuals, dividends on equity holdings are dependent on the performance of the company and are neither guaranteed nor fixed.
Should the business environment be challenging, like it was in much of 2020, REITs may resort to reducing distributions to their unitholders in order to preserve cash and build cash reserves to help weather rainy days. Amid the weaker business outlook, prices of these REITs equity may also dip. During such times, perpetual securities or even bonds may outperform equity.
In the S-REITs and Trust universe, 16 have outstanding perpetual securities. Of these 16 REITs, the dividend yield over the prior 12 months period ranges between 3% to 12%, though dividend yield in the region of 4% to 5% was more common prior to Covid-19.
While there is little meat left for the majority of the REIT bonds in today’s environment, REIT perpetuals may be comparatively better expected returns.
Take Suntec REIT, for example. The dividend yield on its equity over the prior 12 months was 5.03%, with its annualised return over the past five-year period lower at 3.2%. While it is above SUNSP 3.355% ‘25s’ yield-to-maturity of around 2.50%, it is less than the yield-to-call of 3.8% of its perpetual bond which is due for first call in 2025.
In some cases, the perpetual security can be more attractive than the equity and bonds and deserves some consideration and attention from investors looking to deploy cash.
Finally, returns aside, REITs equity is more liquid than REIT perpetual securities and bonds (for they are easier to enter and exit, for example) though prices of perpetual securities and bonds tend to be more sticky.
REIT perpetuals are in style
Last year, a total of $1 billion of REIT perpetual securities were issued across five REITs — a record amount. All the REIT perpetual securities were raised in the second half of 2020 when rates were low.
Of the five issuers, Ascendas REIT and Keppel REIT refinanced their perpetual securities which were due for first call, while CapitaLand China Trust, Suntec REIT and AIMS APAC REIT were first-time issuers who raised perpetual securities to manage their capital structure.
We observed that most of the REITs have become more levered while the cost of debt has come down. The REITs have also rushed to refinance their maturing debt obligations and hoarded more cash amid the uncertainty brought about by the pandemic.
Given that the pandemic has dragged equity prices of REITs down, equity fund raising was less popular in 2020. Even though the total amount of equity raised was somewhat stable year-on-year, 2020 saw fewer REITs tap the equity market.
In summary, REIT equity, bonds and perpetual securities are inherently different and there may be value in holding a portfolio of diversified instruments.
