UnitedHampshire REIT: Risk of Need to Deleverage like US Office REITs

UtdHampshire has released its 3Q results. Below is a summary:

• All in interest cost rose from 3.57% to 4.04% in one quarter
• Interest Coverage Ratio drops from 2.8 times to 2.7 times in one quarter
• Declining Occupancy at Self Storage Segments
• Leverage Ratio now at 41.7%, slight decrease from 42.0% one quarter ago.

If Leverage is more than 45.0%, ICR has to be above 2.5 times

This is the golden rule for all Singapore-listed REITs. At its current leverage ratio, Utdhampshire can suffer a 8% decrease in valuation before it breaches the 45% leverage ratio.

What I am worried is if it can meet the ICR.

ICR "40-60" to Fall Below 2.5 times

Unitedhampshire is facing declining occupancy in self storage segment and the effects of a higher all-in interest rates. 

All in interest has risen from 3.57% to 4.04% in just one quarter and the full effects of its debt renewal at end 2022 has not happened yet and will be shown next quarter; all in interest started to rise only from 1Q2023. The ICR is calculated based on the trailing 12 months interest expense; therefore it is likely the REIT's ICR is going to decline to 2.5-2.6 times.

Rental escalations should put the REIT's ICR back to 2.6 times, but should a Fed Rate hike occur again, there is a real risk that the eventual ICR will fall below 2.5 times. The second risk is its US$21.1million (4.23% interest) which matures in March 2024. It should be renewed at SOFR + 0.75% Margin (6% interest). This adds slightly more to its debt burden. All in by end of 2024, I view UtdHampshire has a 40-60 chance of breaching the ICR of 2.5 times. 

Downward Property Valuation

Due to cap rate expansion, I expect UtdHampshire's year end property valuation to be lower. As mentioned, a decline of 8% will mean Utdhampshire has to go into defensive mode because leverage will exceed 45% and it will have to defend itself to ensure it maintains a 2.5 times ICR requirement.

In 2021, the REIT used a cap rate of 5.75-8%; in 2022, it was 6-7.75%. This resulted in little fair value loss recorded. However, as interest rates have remained high, I do not think Utdhampshire valuers can keep putting overly optimistic cap rates. 2023's Cap Rate should be 6.5-8.5% and the impact will be a 7-10% fair value loss on portfolio.

What the REIT Can Do

In my view, the REIT should move to cut dividends to 90% payout ratio to preserve cash. This is what Elite Commercial did and to a good advantage because it has ensured Elite's ICR has been very healthy.

If the amount saved from reducing the payout ratio is not enough, unitholders have to prepare for some equity raising. There seems to be a need for Utdhampshire to delever to remain in complaince with MAS's rulings. I do expect payout ratio to be cut a bit from its current 100% and I expect the REIT to become a DPU US4.5-5 cents yielder. Still not too shabby considering its current share price.

While UtdHampshire is falling close to the situation PRIME US REIT is in, fortunately for it, it is in a more defensive industry of retail where there is no supply glut. For context, PRIME leverage is 43.7% with ICR of 3.2 times. 

For PRIME, the risk is that it breaches the 50% mark and it forces ICR to go below 2.5 times. In terms of REITs that will breach MAS regulations, my ranking from least likely to most are: Digicore --> Keppacoak--> Utdhampshire--> PRIME--> Manulife US.

The expected dividend and P/B ratio of these counters mirror this reality.

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