Summary of new measures introduced

Key impact on REITs
1. Greater flexibility - Before the new measures last evening, there were concerns being raised (especially amongst retail REITs) that government measures that allowed tenants to defer rents were prejudicial against landlords. Cashflow from rents would have been severely affected while obligations like loans and fixed costs would still have to be met. As tax transparency was calculated based on accounting (accrual) profit rather than actual cashflow, deferred rents would still be accounted for as revenue and REITs would have had to pay out more cash than they had collected. This would have led to a cash deficit in the short run.

The extension in the timeline would allow REITs to defer some distributions until cash was actually collected so that they can conserve cash in the short run to meet more urgent fixed obligations as they ride out the Covid-19 storm. For investors, while short-term distributions could be affected when REITs reduce their payout ratios, the flexibility accorded to REITs would allow them to make better financial decisions for longer-term viability (ie. no need to take on extra debt or dilutive equity fund raisings to pay distributions).

2. More buffer - Due to the impending Covid-19 induced recession, there were fears that asset valuation declines would lead to some REITs breaching the 45% gearing limit. Recall that the gearing is calculated by taking debt over asset value (property valuation makes up almost all of the REITs' asset value). Property valuations are likely to take some hit as income generated from rents could be impacted, especially for retail assets if this pandemic quickens the transition away from brick-and-motar stores. Based on the table below from RHB Research, most REITs would require a >20% decline in asset values before the 50% gearing limit is breached. The 2 closest REITs to breaching the gearing limits are ESR and OUECT.

The higher gearing limit would help to remove the uncertainty over breaching the gearing limit as a result of declining asset values. For some REITs, this also provides it with additional firepower to make opportunistic accretive acquisitions during this period when asset values could be depressed. Examples could be SPHREIT, KDCREIT and FCT which have (and historically had) very low gearing ratios (~30% or less). In particular, FCT has a ready-made pipeline from the PGIM portfolio it currently has a minority stake in with its parent company.

S-REIT debt profiles (Source: RHB Securities Research)

3. Lower cost of capital - As REITs are a dividend paying hybrid of equity and fixed income, valuations tend to be focused on yield and the DDM (dividend discount model). The higher gearing limit could also lead more REITs to have a slight uptick in their proportion of debt-equity funding. As the cost of debt is typically cheaper than the cost of equity (especially now that REIT share prices have been decimated), the higher debt proportion could result in a lower weighted average cost of capital (WACC). This could potentially increase REIT valuations.

Apart from the valuation perspective, a lower cost of capital would allow public listed S-REITs to compete more effectively with private funds which are not subject to such limits. Previously, a REIT may have been outbid by private funds which can make acquisitions accretive to themselves (private funds) as they have a lower cost of capital.

Overall I think most would agree this is a positive step by the 3 government bodies to give some breathing space to S-REITs. The market was also in strong agreement with a number of REITs being up >5% today. While the measures provide S-REITs with additional funding buffers, I believe the key would be to see what REIT managers do with them. At the end of the day, markets would still accord a premium to managers (lower yield spreads, higher P/B) that have better capital management strategies and come out of this Covid-19 situation stronger.

S-REIT prices sorted by trading value (Source: SGX)