A QnA with Nupur Joshi, CEO of REITAS (REIT Association of Singapore).
The Edge Singapore: The S-REIT sector’s signal of easier interest rates is welcome. How can S-REITs fortify themselves against future challenges? What lessons have we learnt from the latest crisis?
Nupur Joshi: The last 4½ years have been extremely challenging for REITs, starting with the Covid-19 pandemic in 2020 to 2022, followed by an unprecedented rise in interest rates from 2022 to 2023, the effects we are still experiencing. A turn in the interest rate cycle, as indicated by the US Federal Reserve (Fed), will be a huge relief to the sector and the hope is that the first interest rate cut in September will be the beginning of a steady reduction in interest rates over the next few months.
In some ways, many lessons learnt from previous crises, like the 2007- 2008 Global Financial Crisis (GFC), helped REIT managers survive the last few years. For example, the GFC taught the industry the criticality of maintaining a strong balance sheet by ensuring adequate lines of credit, having a staggered debt maturity profile and reducing gearing levels.
One of the first things some REIT managers did when the Fed started raising interest rates in 2022 was to fortify their balance sheet by increasing the hedged (fixed) component of their interest cost and staggering their debt maturity profile. They also tried to refinance their debt early and, where possible, lower their gearing level.
Another important lesson from the past, particularly relevant for REITs with significant overseas properties, is the importance of diversification. One key benefit of diversification is that it cushions against different property cycles in different geographies and asset classes.
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Overall, REITs with properties outside Singapore in more than one asset class and geography were more resilient than single-country or single sector REITs. Singapore is an exception, with investors favouring REITs with significant local properties due to its reputation as a safe haven.
A third lesson was to redouble focus on asset management. When the external environment is challenging, it makes sense to focus on extracting the maximum value from your existing portfolio (since acquisitions become challenging). REIT managers, therefore, rightfully focused on maintaining high occupancy levels, conducting asset enhancement initiatives to keep buildings attractive for tenants and, where feasible, undertaking redevelopments. Asset recycling, such as selling older, underperforming properties to buy higher-yielding new properties, also gained traction as REIT managers used the sales proceeds to fund their acquisitions (rather than borrow at high interest rates).
A fourth lesson is the importance of being alert and agile. REITs that were able to tilt or pivot towards more in-demand sectors like logistics, data centres or student accommodation were able to make their portfolio more resilient.
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Finally, past crises reminded us of the importance of REIT managers enhancing communication, staying transparent and keeping investors updated on the steps they take to manage challenges.
Overall, the S-REIT sector has managed to survive the last few difficult years and we are optimistic that with the expected downturn in interest rates, the industry can expect better days ahead.
The Edge: It is clear that investors prefer REITs with a Singapore core as part of their portfolio and have voted with their pockets by selling down S-REITs with overseas assets. How can confidence in overseas assets return? Is the damage brought on by the Chinese and US S-REITs irreparable? What can managers of overseas REITs do to attract new investors?
Joshi: It is natural for investors to prefer REITs with a strong focus on Singapore. Home bias provides a sense of comfort and the Singapore dollar’s strength has further reinforced this preference. However, only three out of 41 listed S-REITs have all their properties in Singapore. So, the discussion of REITs with overseas assets largely blends with that of the entire sector, as over 90% of REITs own overseas properties. The risk-return characteristics of REITs with overseas properties have not been fully understood by many investors. To some extent, sentiment has also been impacted by the troubles of the US office and China REITs. There are additional risks when investing in REITs with significant overseas portfolios, such as currency risk, geopolitical risk or local market dynamics. Investors are right to expect a higher dividend yield when taking these on.
The question is, how much higher? Historically, the average dividend yield of the S-REIT sector has been around 6% to 7%, but now there are numerous REITs trading at double-digit yields. The steep discount is also clear if we compare the sector’s historical P/B versus now. The 10-year P/B of the S-REIT sector is around 1.02 times, while the P/B of most REITs today (excluding the outof-favour US Office REITs and the infavour industrial REITs) ranges from 0.5 times to 0.8 times.
Given that REITs, including those with overseas properties, are showing signs of operational stability and further sharp declines in property values now seem unlikely, as evidenced by the latest June-end results, the uncertainty surrounding overseas REITs is diminishing. This creates an opportune moment for investor sentiment to improve and to narrow the valuation gap. For their part, REIT managers, especially those with significant overseas portfolios, need to deliver steady distributions, articulate their strategy clearly, including diversification benefits and be transparent in their communications with investors. The bar to win investors’ hearts is higher for these REITs, but it takes two to clap and these REITs deserve more affection and attention from the investing public.
The Edge: Increasingly, REITs have looked within their portfolios to raise cash rather than leaning on investors. What other ways REITs could better manage their portfolios to appeal to investors?
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Joshi: While the interest rate cycle is turning, rates will unlikely return to levels in the pre-Covid-19 era soon. As such, some of the strategies S-REITs have adopted during the last few years will likely continue. These include asset recycling, pursuing asset enhancement initiatives and redevelopment. Reconstituting their portfolio towards in-demand sectors can help S-REITs stay aligned with market trends and attract investors seeking exposure to resilient, growth-oriented sectors.
REITs that are fortunate to have a financially strong sponsor willing to support them in pursuing growth opportunities can also depend, in part, on this funding avenue.
Another strategy REITs are undertaking is increasing the proportion of green-certified buildings in their portfolio. This will attract higher-quality tenants and environmental, social and governance (ESG)-focused institutional investors.
REITs can also explore new funding sources, such as sustainable finance, to attract ESG investors or tap into the bond and perpetual markets to diversify their capital base and reduce dependence on equity financing. With the Monetary Authority of Singapore (MAS) deliberating on having a single gearing limit of 50% and lowering the interest coverage ratio (ICR) requirement to 1.5 times (from 2.5 times), it will be a bit easier for REITs to raise debt capital and pursue growth opportunities. As the cost of capital gradually reduces, property acquisitions will likely increase. The pace of increase will largely depend on the magnitude and frequency of Fed rate cuts.
The Edge: What motivated the MAS’s proposals for a single-tier aggregate leverage ceiling and an ICR floor? How do these changes impact REITs’ capital management, given that those with higher ratings and lower debt often enjoy lower capital costs?
Joshi: REITAS welcomes MAS’s proposal to have a single aggregate leverage limit of 50% and a floor ICR of 1.5 times as it simplifies the gearing requirements by providing a clear and consistent framework while at the same time ensuring that a REIT has sufficient funds to pay its interest obligations when they fall due.
The interest rate environment has changed dramatically since MAS introduced the 2.5 times ICR requirement in July 2020. The Fed Funds target rate was extremely low at 0% to 0.25% then. However, between 2022 and 2023, the Fed raised interest rates by an unprecedented 11 times, a total of 525bp increase in 16 months, to 5.25% to 5.5% today, dramatically increasing REITs’ interest expense. At the same time, property yields did not increase in tandem, which resulted in significant pressure on REITs’ ICR.
Given the changed interest rate environment, it is sensible for MAS to propose a lower ICR of 1.5 times. This is closer to the level lenders consider and is a better proxy for associated risks. A single gearing limit of 50% for all REITs provides a bit more debt headroom and flexibility to REIT managers and reduces the pressure to do equity fundraisings (when the REIT’s gearing crosses 40%), especially when the REIT’s stock price is depressed. This ultimately benefits investors as it avoids dilutive fundraisings.
Additionally, a gearing limit of 50% is a bit closer to the 60%-75% gearing that private funds employ when bidding for assets, and this makes S-REITs a bit more competitive when bidding for quality properties alongside other local and overseas players.
The new proposals will initially benefit S-REITs with higher gearing and lower ICR, but in the medium term, all S-REITs will gain. The single-tier 50% gearing limit and more reasonable ICR requirement of 1.5 times will provide REITs greater flexibility in managing their capital structure and help reduce the weighted average cost of capital.
The Edge: How can smaller S-REITs survive in an environment where size and liquidity appear as key considerations for institutional investors?
Joshi: Many of today’s large REITs started small and built their scale over time by following a deliberate strategy. They focused on acquiring good quality properties in the right locations, at the right price and with a well-balanced funding mix. They also delivered consistent returns. This careful approach helped them earn investor trust, creating a virtuous growth cycle. For example, the market capitalisation of CapitaLand Integrated Commercial Trust C38U C38U 20 years ago in 2004 was $2.1 billion, compared to $13.3 billion as of June this year. So, it takes time and consistent execution, but with each year of steady performance, investors gain confidence in the REIT manager and become more willing to support its growth.
The Edge: Investors prefer higher distributions and are not fully sold on ESG spending. Why does ESG matter to REIT managers and how should they message this to their investors?
Joshi: The focus on ESG within the corporate world started gaining traction about three to four years ago when it became clear that climate change would be the next major global challenge after the pandemic.
While REITs have responded by ramping up their sustainability efforts, the immediate impact on unit price has been less evident. This is largely because equity investors have been more concerned with the operational and financial difficulties REITs faced during the challenging past few years. However, as the interest rate cycle turns and REITs’ financial performance improves, investors will likely emphasise ESG performance more. REITs with stronger ESG credentials are expected to attract more investor attention in this environment.
Many analysts are now incorporating ESG metrics into their investment analysis and investment management firms have become more sophisticated in factoring sustainability into their decisions. Beyond investors, multinational tenants increasingly require that the buildings they lease meet specific sustainability standards, such as green certifications.
There is a common misconception that focusing on ESG will come at the cost of distributions. However, this isn’t the case. By prioritising ESG, REIT managers protect longterm revenue by ensuring that their buildings meet tenant sustainability demands, reducing operational costs by introducing energy-efficient upgrades and improving corporate governance and transparency. Together, these will protect the values of the property and investment. Finally, by obtaining green building certification and committing to sustainability targets, REITs can tap into the growing pool of sustainable finance. While the benefits of ESG may not be immediately apparent to investors, it is only a matter of time before the market starts rewarding REITs with stronger sustainability credentials.
Click here to learn more insights about REITs from the REITs Reiterated series.
