The Code of Collective Investment Schemes (CIS), which the S-REITs fall under, will be amended to streamline leverage requirements including the definition of the interest coverage ratio.
Investors usually invest in REITs for their distributions rather than their capital returns. Hence, although REITs are a hybrid, a key part of their investment returns is their ability to distribute distributions and distributions per unit (DPU). Credit risk for S-REITs is based on their ability to pay DPU, which is heavily reliant on the financial health of the company.
A key factor is the REIT’s capacity to cover its interest cost and pay distributions, which depends on their interest coverage ratio (ICR), a metric that credit analysts focus on.
On Nov 28, the Monetary Authority of Singapore (MAS) made the reporting of ICR mandatory.
“To rationalise requirements, a minimum interest coverage ratio (ICR) of 1.5 times and a single aggregate leverage limit of 50% will be applied to all REITs with immediate effect. The previous requirement was that a minimum ICR of 2.5 times was imposed only on REITs which intended to increase their aggregate leverage from 45% to 50%,” says MAS.
In addition to these new regulations, REIT managers will have additional disclosures that apply from March 31, 2025. REITs will need to disclose sensitivity analyses on the impact of changes in ebitda (earnings before interest, tax, depreciation, amortisation — the numerator in the ICR formula), and interest rates on REITs’ ICRs.
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The sensitivity analyses should minimally include two separate scenarios, one based on a 10% decrease in Ebitda and another based on a 100-basis point increase in interest rates, MAS says.
Where the ICR of a REIT has fallen below 1.8 times, the REIT manager should take steps and/or have plans in place to improve the REIT’s ICR, and disclose this additional information, MAS adds.
Interestingly, Lippo Mall Indonesia Retail Trust’s (LMIRT) adjusted ICR is at 1.55 times as of Sept 30, the end of its 3QFY2024.
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If a REIT's ICR falls below 1.5 times, the manager would need to notify MAS of the breach and rectify the breach in accordance to the provisions in the CIS Code. The manager should also not enter into any transaction that would increase the extent of the breach.
REIT managers will also have to report on the outlook and management of their leverage and ICR levels in their interim financial result announcements and annual reports, MAS says.
An important change is the definition of the interest coverage ratio which takes into account distributions of perpetual securities. Since MAS introduced the ICR into REITs’ financial reporting in 2022, REITs reported ICRs on a trailing 12-month basis, and separately on an adjusted basis (adjusted ICR), which includes the impact of the coupon of their perpetual securities.
Since the “adjusted ICR” definition was put in place in January 2022, the industry has adapted to the reporting of adjusted ICR in the past two years.
MAS announced it will streamline the computation of ICR to the trailing 12 months’ ebitda excluding effects of any fair value changes of derivatives and investment properties, and foreign exchange translation, divided by the trailing 12 months’ interest expense, borrowing-related fees and distributions on hybrid securities (including perps).
Market-watchers are likely to be happy that only one ICR figure will be reported. To date, REITs with perpetual securities have been announcing more than one value for their ICR. Often the adjusted ICR figures, which include the impact of perps, are in their footnotes.
A couple of S-REITs either do not announce their ICRs at all, such as BHG Retail REIT BMGU , or announce it in a financial statement rather than the presentations slides, such as LMIRT.
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Separately, aggregate leverage increasing to 50% takes into account the declines in valuations during times of high interest rates, which indirectly affect valuations through discount and capitalisation rates.
In response to feedback from the industry and the REIT managers to the initial proposal in July, three respondents disagreed with the proposal and expressed concerns that an ICR threshold of 1.5 times may worsen the risk profile of REITs.
On the other hand, a few respondents proposed for the aggregate leverage limit to be increased to 60%, citing that REITs were ultimately subject to market discipline and that MAS’s leverage requirements for REITs remained one of the strictest internationally.
In July, when these changes were first mooted, Vijay Natarajan, vice-president, real estate and REITs at RHB, said the proposal to simplify aggregate leverage and ICR requirements “provides greater flexibility and clarity while ensuring prudence. It also gradually shifts the managing appropriate debt levels onus to REIT managers and market mechanisms.”
In his view, the beneficiaries are likely to be the smaller overseas REITs, and a couple of larger REITs, which use perps in their capital structure.
Based on The Edge Singapore’s Big REIT table, three REITs have their ICRs either at 1.8 times or below 1.8 times, with a fourth REIT approaching 1.8 times.
