SINGAPORE (Apr 24): Covid-19 has upended several orthodoxies. One of them is the view that retail REITs with suburban malls are the most defensive in the sector. To prevent the spread of the coronavi-rus, most retail outlets are closed.Singapore’s Temporary Measures Bill (TMB) allows stressed tenants to hold off paying rent for six months.
However, retail REITs have to support their tenants, perhaps by collecting very little or no rent, or giving them rebates. This means the REITs would see lower income.The lack of rental income will affect several aspects of retail REITs. These include distributable income and DPU as well as interest coverage ratio and the ability to meet interest expense. In addition, the sharp decline in rental income and net property income could also impact their valuations. That, in turn, would affect aggregate leverage or gearing levels of REITs as they measure debt against assets. If asset levels are set for a decline, gearing would rise even though the REIT has not taken on any additional debt.
Help from regulators
To pre-empt valuation declines and the problem of REITs breaching their gearing limits, regulators have stepped in. The Monetary Authority of Singapore (MAS) on April 16 announced that the gearing ceiling is lifted with immediate effect.In addition, MAS, the Ministry of Finance (MOF) and the Inland Revenue Authority of Singapore (IRAS) jointly announced they will extend the timeline for S-REITs to distribute at least 90% of their taxable income from three months to 12 months after the end of their FY2020 to qualify for tax transparency.To qualify for tax transparency treatment in FY2020, REITs with year ending March 31 and Dec 31 will have up till March 31, 2021, and Dec 31, 2021, respectively, to distribute to their unitholders at least 90% of their tax-able income derived in FY2020.This means REITs will be able to retain some of their cash flow to help their tenants as part of the government’s relief measures, and to fulfil conditions set out in the TMB.
Tough times ahead
Retail REITs say this year will be a year like no other. On April 9, Lease Global Commercial REIT, which owns 313@Somerset, said that various measures introduced by the Singapore government will impact its contribution to Lendlease REIT’s distribndleutable income from April 2020 onwards com-pared to the forecasts announced in the IPO prospectus last year.
Lendlease REIT has a June year end, so if the Covid-19 situation persists through this year, its 2HFY2020 and 1HFY2021 will be adversely affected. According to the prospectus, Lendlease REIT had a forecast DPU of around 5.1 cents for this year and 5.3 cents for 2021.
Lendlease REIT owns two properties, Sky Italia, which contributes 33.9% to NPI, and 313@Somerset, which was expected to con-tribute the remaining 64.1%. For the three months to Dec 31, 2019, 313@Somerset con-tributed $10.7 million in NPI or 66.1% of NPI, to Lendlease REIT. Lendlease REIT’s manag-er says Sky Italia has made all its rental pay-ments in a timely manner.
In response to queries by the Singapore Exchange, Lendlease REIT has stated that 313@Somerset has been directly affected by the Covid-19 outbreak and measures like rent relief. Therefore, the percentage contribution of 313@somerset to Lendlease REIT’s NPI is expected to decrease.
The first REIT to report its results was SPH REIT on April 1. Its DPU for 2QFY2020 to Feb 29 fell 78% y-o-y to 0.3 cent. This is despite income available for distribution rising 12.2% to $41.5 million. The decline in DPU is mainly due to the conservation of cash by SPH REIT as it expects operational outlook to worsen and cash flow to remain uncertain amid the pandemic. This decrease is on the back of an expected need for additional tenant assistance and prudent cash flow management in view of the new legislation that may impact the collectability of rents, the REIT’s manager says.
On April 1, CapitaLand Mall Trust’s manager had a teleconference with analysts. The REIT manager said tenants were allowed to draw down on their security deposit for their rents in March to ease cashflow needs. Most tenants will not be required to pay rents for April and May. If the situation deteriorates further, CMT’s manager will not rule out further tenant support by both government and landlord. CapitaLand, CMT’s sponsor, has committed $100 million in support of its malls’ tenants.
CMT owns 15 malls, including Raffles City, Clarke Quay, and IMM which are viewed as discretionary- spending malls. CMT’s manager says it will look to suspend non-essential operating and capital expense to conserve cash. AEI and redevelopment plans will also take a backseat for now.
Standard & Poor has downgraded Frasers Centrepoint Trust’s rating to BBB from BBB+ as rent moratoriums are likely to hurt FCT’s cash flow, the ratings agency said on April 13. UOB Kay Hian downgraded both CMT and FCT to neutral earlier this month, and expects a 22.8% drop in CMT’s DPU this year to 9.87 cents, and an 18% drop in FCT’s DPU this year to 9.68 cents.
Rental revenue, or lack of revenue is likely to impact debt servicing financial covenants and valuations. If interest coverage ratios fall below certain levels, financial covenants could be breached. As a result, MAS has deferred the implementation of a minimum interest coverage ratio (ICR) of 2.5x till 2022. United Hampshire US REIT which listed in March this year has an ICR of 2.3 times, according to a UOB Kay Hian report dated Apr 15. Other REITs with low ICR are Mapletree North Asia Commercial Trust (MNACT) (2.5x), EC-World REIT (2.6x), Far East Hospitality Trust (2.8x) and Suntec REIT (2.9x).
No plans to defend DPU
CMT’s manager says it does not plan to de-fend DPU with capital top-ups and would rather conserve cash and look after its ten-ants. It would, however, consider taking man-agement fees in units. Last year, MNACT offered to defend DPU with capital top-ups following the closure of Festival Walk due to the unrest in Hong Kong. On Dec 4, 2019, MNACT’s manager said it would implement a distribution top-up which was on the basis that Festival Walk was closed for repair works. The top-up will be based on 40% of the projected Festival Walk retail revenue for the October-December quarter and the January-March quarter. MNACT will announce its FY2019/2020 results ending March 31, on April 29.
The manager of CapitaLand Retail China Trust (CRCT) has mulled defending its DPU with capital top-ups from profits of asset sales. Some of CRCT’s malls in China were closed temporarily because of Covid-19. All of them have reopened, and are seeing a rebound in shopper traffic although not quite at the levels in 2019.
Sasseur REIT’s manager says while 1QFY2020’s DPU will be adversely impact-ed by the closures, Sasseur REIT’s unitholders will continue to receive the fixed compo-nent of DPU in accordance with its Entrusted Management Agreement.
New gearing limit holds off default
Zhao Yiyuan, an analyst at Soochow CSSD Capital Markets, says the new gearing limit will be helpful for some of the REITs which may need to raise more debt to hold off de-faults. In addition, REITs will be able to withhold DPU because of the temporary tax measures, to help pay for interest expense.
As a result of these measures, REITs may not need to partake of equity fund raising (EFR) despite not collecting rental for up to six months. Since government rebates cover around one month of rent, and most REITs hold around three months of security deposits, most REITs could probably survive as long as 10 months with no rental income, Zhao suggests.
“According to our calculations, interest expense represents around 16% of REITs to-tal annual revenue or around two months’ worth of total annual revenue. Therefore, on average, REITs would need to borrow or with-hold distributable income to cover FY2020’s interest payments after 10 months of no rental evenue,” Zhao writes in her report.
In a scenario where REITs forego six months of rental income, they would still have an average of four months buffer from government rebates and security deposits before they default on interest payments.
“Before taking on short-term borrowings, we think REITs could likely utilise withholding their distributions methods (given new leeway provided by new regulation of up to 12 months tax-exemption) to manage cash flow mismatches,” Zhao says, adding that REITs can always borrow more to pay interest payments. Hence a default is unlikely.
According to her, the REITs with the highest interest cost as a percentage of revenue are Keppel REIT, EC-World REIT and Dasin Retail Trust. Among the retail REITs, Zhao estimates interest expense represents 17% of total rev-enue, and for hospitality trusts, interest expense comprises 13% of total revenue. “Therefore, if this no-rental period is prolonged to more than 10 months, then we could start to see these REITs taking on more debt, before going the EFR route,” she reckons.
Valuation impact
Outlook for rents and forecasting future cash flows are necessary metrics in the valuation of investment properties. For at least two months, rental revenue is likely to be to be hit for all the malls in Singapore. Beyond that, it would depend on whether Covid-19 has been curbed. Therefore, valuers are unlikely to build in any growth in rental.
In a report dated April 21, Cushman & Wakefield said, “Given an impending recession, prime rents are expected to fall across the board in 2020. Orchard Road will see the largest impact as restrictions on tourists are likely to persist. Suburban malls are expected to show the most resilience as consumers would still carry on with necessity shopping albeit at a lower frequency. Going forward, retail rents across the board are expected to decline in 2020 as recession worries and uncertainties regarding Covid-19 remain.“
For most retail REITs, although DPU and hence valuations could be under pressure, a breach of the 50% gearing ceiling is unlikely.
Lippo Mall Indonesian Retail Trust (LMI-RT), which owns 23 malls and seven retail spaces in Indonesia, had announced a temporary closure of all its properties for two weeks to April 9. This has now been extend-ed to April 28. It is unclear if the loss of income will be compensated by rebates from the Indonesian government. LMIRT is in no danger of breaching its new 50% gearing limit. Its gearing as at Dec 31 was 34.7% so if its perpetual securities are included as debt, LMIRT would have breached the old 45% ceiling.
When SPH REIT announced that its DPU had tumbled 78% y-o-y in 2QFY2020, it also announced that income available for distribution rose 12.2% y-o-y. Hence, the impact on valuation would have been limited. At any rate, with a gearing of 29%, it is unlikely to breach both the old 45% gearing ceiling and the new 50% gearing ceiling. And SPH REIT will obviously meet its interest payments given it is holding back on DPU.
In addition to rental revenue, valuations are determined by capitalisation rates and discount rates. These are indirectly affected by policy interest rates and risk free rates which are on a downward trend. The US Federal Reserve has announced unlimited quantitative easing, plans to buy junk bonds, and the is-suance of collateral loan obligations (CLOs) and commercial mortgage backed securities (CMBS) which played a big part in the Global Financial Crisis.
The impact of the Fed’s announcement is likely to result in continued low policy interest rates, low 10-year bond yields and a lot of liquidity sloshing around. Hence, despite a poor rental outlook for the retail REITs, their capitalisation rates and discount rates are unlikely to rise. These opposing factors may stop retail REIT valuations from falling too much.
