Path to prosperity

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)

Westlite Toh Guan (Source: Centurion Corp)

Overview
Centurion derives about 2/3 of its revenue from purpose-built worker accommodation (PBWA) in Singapore and Malaysia with the remaining coming from student accommodation (PBSA) in 5 countries. With lower frills, the PBWA can achieve a higher profit margin than PBSA and contributes about 77% to the group total segment profit as of FY18. According to a Euromonitor report a few years back, Centurion holds the largest market share in Singapore PBWA with >10% of industry revenue and bed capacity. Bed rents are paid by employers and contracts tend to be 12 months with 1-2 months of security deposits.

Centurion's global portfolio of PBWA/PBSA (Source: Centurion Corp)

Impact from Covid-19
With foreign worker dormitories being one of the larger clusters in Singapore, there has been a significant increase in media attention regarding the living conditions of foreign workers in Singapore. To this end I think once this crisis passes, the Foreign Employee Dormitory Act (FEDA), which regulates standards for foreign worker housing, will be reviewed and have its standards raised. This would be positive for Centurion as it could eliminate other sources of accommodation like factory-converted dormitories and lower quality PBWAs. Within the industry, Centurion dormitories have been known to have one of the higher standards of living conditions.

In the short-term, I do not foresee many employers defaulting on their payments for worker accommodation as this tends to be a small proportion of their costs. Having workers shift out of dormitories to alternative sites like army camps also do not release employers from their obligations to Centurion. To date, Centurion has not announced any rental rebates for tenants.

On 2 Apr 2020, Centurion also announced a delay in its redevelopment of Westlite Toh Guan which was slated for April 2020; the delay will be until the Covid-19 situation in Singapore normalizes according to its CEO. I think this is a slight positive as the funds set aside for the asset enhancement capex can now be an additional buffer if cashflow is constrained during this period.

On the PBSA side, rents could be negatively impacted as foreign students return home and vacate their premises. There could also be pressure to provide rental refunds for those students to keep up its reputation as a fair student accommodation provider. In the mid-term (once the virus passes), there could be an uptick in demand for PBSA especially if a global recession ensues. Historically, university enrollment rates see a rise when the economy is in a downturn as the opportunity cost of not working is reduced due to weaker employment prospects in the job market.

Centurion's PBSA properties in Australia (Source: Centurion Corp)

Overall, I think Centurion has a good long term future due to its dominant position in PBWA in Singapore and Malaysia and its foray into an increasingly popular student accommodation asset class. I think the cash generative (positive operating cash flow) and high gross profit margin (~70%) nature of the business gives it a buffer to cushion against any of the abovementioned short-term negatives.  However, investors should expect to bear with near-term volatility due to the impact of Covid-19.