The upcoming reset in perpetual securities (perps) may become an “increasingly pressing issue” for Singapore REITs (S-REITs) as interest rates remain elevated, says DBS Group Research analysts Dale Lai, Derek Tan and Amanda Seah. About $1.1 billion worth of perps can be called in FY2024. Of that amount, 42% have their first call date this year. The remaining 58% can be redeemed at every coupon date for most of the perp issues.
In FY2025 and FY2026, S-REITs will have a further $1.3 billion (in FY2025) and $1.7 billion (FY2026) in perps due for their first calls.
While perps were popular in the last decade due to the low interest rate environment, the instrument is less attractive today due to the higher rates and could hurt distributions upon their reset.
“We estimate this could erode distributions per unit (DPUs) by up to [around] 4.0% (in FY2026) for selected S-REITs. This is a potential hurdle that most S-REITs and investors will need to keep watch on,” the analysts write in their April 11 report.
While perps were previously redeemed or refinanced on their first reset date, issuers prefer to reset them instead, due to the tight liquidity environment and high interest rates.
To Lai, Tan and Seah, the decision is not likely to be as straightforward.
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As such, the team has identified a few strategies, which are: to allow a reset of the coupon rates; to redeem or call the perps back and funded by new bank loans; or conduct asset divestments.
“We believe most S-REITs will redeem the upcoming perps, though funding strategies will depend their capital structure, financial flexibility, and headroom,” they say.
Resetting perps will result in trade-offs between DPUs and higher gearing ratio among others, note the analysts.
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On this, REITs like CapitaLand Ascott Trust HMN (CLAS) and Paragon REIT, which have “good financial flexibility”, may consider multiple strategies for redeeming their perps without overly stretching financial metrics.
REITs with perps resetting in 2025 may see mitigated downside risk to their DPUs due to a more benign interest rate environment.
In a bear case scenario of a “higher-for-longer” interest rate environment, REITs like CapitaLand Ascendas REIT A17U (CLAR) will have sufficient financial flexibility to consider their options while REITs like AIMS APAC REIT (AA REIT), Lendlease Global Commercial Trust (LREIT) and Suntec REIT, whose debt ratios are most stretched at around 45% and above, should look to divest their assets to prepare ahead.
What are perpetual securities?
The analysts define perps as a hybrid instrument that are used to diversify a REIT’s capital base and additional debt-funded headroom. Perps, which combine the characteristics of both debt and equity, are recorded on the balance sheet as the latter. The instrument pays a fixed coupon to investors and generally rank ahead of equity holds in the capital stock; their coupons are paid before DPUs. It is due to this that equity investors view perps as “quasi-debt”.
“For S-REITs, perps are a double-edged sword. Gearing levels are lowered given that they are recorded as equity, providing REITs with more headroom to debt fund acquisitions,” write the analysts.
“However, the regulators have safeguards preventing overuse of this asset class with the REITs having to achieve an adjusted interest coverage ratio (ICR) including perps coupon payments of 2.5 times before being allowed to gear up to 50%,” they add.
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A typical series of S-REIT-issued perps are priced using the current benchmark rate in Singapore with an added credit spread, which is usually a function of the issuer’s credit rating. The spread can range from 1.8% to 5.2%. The first call date of a perp is usually in five years. Then, the issuer can opt to redeem the series at par or reset the perps based on the prevailing benchmark rate with the option to call the series at every distribution payment date thereafter.
The first perps
Mapletree Logistics Trust (MLT) was the first REIT to issue perps in March 2012. The issuance raised $350 million at a cost of 5.375%.
“The maiden perps’ issuance received very healthy interest from investors, and the order book was over three times subscribed,” note the analysts.
In 2015, the instrument gained popularity among the rest of the REITs when the Monetary Authority of Singapore (MAS) lowered the leverage cap for S-REITs to 45% from 60% previously. That year alone, a total of $700 million in perps were issued.
With perps regarded as equity instead of debt, this allowed REITs to use their proceeds raised to fund further acquisitions and lower leverage.
In 2020 and 2021, a time when interest rates hit “rock bottom” and with the economy recovering from the Covid-19 pandemic, perps regained their popularity. This also came at a time when REIT managers anticipated declines in their portfolio valuations.
“More S-REITs started to issue perps in that period to fund portfolio rejuvenation initiatives and also help shore up their balance sheets,” the analysts note.
From 2012 to 2022, S-REITs have issued around $5.68 billion worth of perps in total. These REITs currently have $4.2 billion of perps outstanding.
