MAS Latest Changes For REITs: 50% Leverage and 1.5 times ICR (which includes Hybrid Securities Distribution)

The latest MAS rules for REITs is simple and helps to ease some of the pressure on leverage.

Summary

Basically, MAS has simplified the limits and can be understood simply as:

(i) REIT leverage should not exceed 50%;

(ii) Interest Coverage Ratio, ICR, (including distribution from hybrid securities) should not be lower than 1.5 times, a decrease from the previous 2.5 times. And sensitivity analysis to be reported under situations of drop in property income or interest rate rises

My Thoughts

These changes help investors understand the regime much better because previously there was a 45% leverage limit and a 50% leverage limit with an "if" condition. Everything is now simplified and even for what is defined under the ICR, it is clear. No more wriggling their way out (for the Mapletree REITs).

Higher Leverage Limit

It is definite good news for all REITs since their regulated leverage limit has been raised and it is now cap at 50%. Suntec REIT is a definite beneficiary as they were hovering near the 45% limit and had a very low interest coverage ratio.

The US REITs are another group of beneficiary with 2 out of the 3 REITs having exceeded the 45% leverage limit and walking on thin ice for their ICR. It is worth noting for both PRIME and Manulife (MUST), their ICR are at 2 times range but due to their revaluation of properties they were close to breaching/have breached the regulatory limit for leverage. So in a way, the new rules help ease pressure off and for MUST it gives a boost to their deleveraging strategy.

Market Movements

While there was not much price movement in the REITs space post the news on 29 November 2024, I do take the news as a positive. With a higher and clearer definition of leverage, it gives assurance to the distribution of REITs (of course the distribution of REITs will still be affected by the property income, which affects ICR too). 

This is a plus and I will evaluate increasing my portfolio to REITs knowing there is a less stringent regulatory limit in place giving more headroom for (i) troubled REITs to breathe and in turn resume dividend or (ii) REITs with stronger balance sheet can now take on more AEI or smaller buildings to increase income.

Manulife US REIT: Expect Lower Occupancy and Expectations of Its Divestment Plans (Nov 2024)

As expected, the office building in Capitol of Manulife US REIT (MUST) portfolio was sold. One of the main reason why I thought Capitol would go was because it is a good asset with a high occupancy rate relative to other offices in MUST's portfolio.

2024 Divestment Target (108/230)

Based on its 2023 restructuring plan. MUST has to sell US$122 million more in property valuation. While its Tranche 1 buildings are placed on the market, I do feel 02 buildings (which coincides to how many they had placed for sale) would be negotiated for sale close to the agreement deadline; just over the line to achieve US$122 million

Tranche 1 Assets are Weak

Figueroa- Expected sale but a big downward valuation. Figueroa is currently valued at US$139 million for end 2023. However, in its submarket, the sales of its comparables are at US$137-$140 psf. Realistically, Figueroa is worth about US$100 million.

Diablo- Majority of its tenants are vacating end 2024, it is likely occupancy will drop to 30% level. Being an old office building of Class B status, I think further downward revaluation will happen. The building looks like a US$30 million value and likely NPI will turn negative in 2025 Letting it sit on MUST book will be a big negative. Likely this building will be demolished by either MUST or a new buyer.

Penn- Another old building in MUST portfolio. Questions will be raised if the US Treasury will downsize its office space in Penn, which I believe is likely. No doubt refurbishment was done but it is an old building that regularly needs maintenance CAPEX to ensure its lifespan. I  expect it to be worth about US$80 million.

Centrepoint- Has the lowest amount of expiring leases among the 4. In terms of value, it is likely the most resilient and can fetch US$65 million range.

Overall Lower Occupancy, Likely Lower Valuations

Expect another downward valuation come end 2024. "Green shoots" of recovery is not here. It is unlikely the re-valuation will result in a convenant breach of leverage ratio of 80%.

I do not expect the submarkets MUST are in to recover until end 2026. However, the REIT has to complete its divestment plan by mid 2025. It has to sell about US$200 million more in properties.

The need to raise liquidity is putting the REIT in a weak position for sales negotiation. Buyers know it has to sell and during a time when office spaces are still weak.

PRIME US REIT Thoughts: Future Plans in 3Q results and what CEO has to do to Improve Sentiments

Exactly 02 months ago, PRIME REIT's CEO Rahul Rana went for an interview and in the article he explained about how PRIME US REIT plans to convey to investors of where the REIT is today and where it is heading. All these to improve sentiments and bring share prices back.

3Q results came out and in this section of PRIME US REIT's slides, they did tell us the 03 year plans of the REIT:

In it, PRIME REIT listed 06 steps it will take. Step 1 to 4 are indeed sound and what the REIT has been doing. At a leverage ratio of 45.4%, it is indeed sound for PRIME to improve property valuations so that the amount of debt remains the same but leverage will fall mathematically.

Step 6 is something I am definitely looking forward to because, as investors, we are buying a REIT for dividend and for a REIT to resume its dividend, this mean business as usual.

Step 5 is something I have views about.

How to Improve Sentiments and Share Prices

To address the elephant in the room, PRIME US REIT share prices are indeed low. At current 0.3 times of price to book value, investors are indeed pricing the REIT in distress despite the successful refinancing. To me, there could be 02 reasons behind it

High Leverage

PRIME's leverage stands at 45.4%, it is probably too high for many investors liking, If PRIME is able to drive occupancy and in turn improve valuations, pushing the leverage to 40.X% and below, it would do wonders to sentiments. This can be achieved by two ways. 

Firstly, improvement in property values and secondly paying down the debt. What is interesting is that PRIME drew down on its revolving credit this quarter, this intrigues me and I though it was not financially wise to do so. Personally for this half of the year, I feel PRIME should keep to distributing only 90% of taxable income with the rest dedicated to paying down the loans.

The first priority to PRIME is to target 40.X% and below leverage ratio, without the need of diluting existing shareholders via rights issue or share placement. This is very important. The REIT should focus on it and stop drawing down on too much loan from its credit facility.

Paying More Dividend

From 2025, PRIME should resume paying out good dividends. In my view, where the share price is now is because sentiments do not think PRIME will restart a good payout to investors. PRIME has to be forthcoming in its dividend plans for its upcoming year end financial report. It has to guide with a ratio for its dividends such as "90% of DI to be distributed". This is what Unitedhampshire US REIT has done.

If the management wants PRIME to be valued at say 0.6 times book value, it has to consider how much to pay. In my view, from 2025, the market will likely value PRIME at 7-8% dividend yield of what it pays out. Hopefully, the management gets my hint. 

If it wants PRIME to be at say 30 US cents, payout has to be 2.4 US cents. If it cannot achieve it due to its cashflow, management will know share prices will be much lower and their perceived undervaluation will remain.

However, the REIT has to be cognizant its leverage ratio should not be compromised like in the past where it was paying out 100% of distributable income and increasing its leverage to pay for CAPEX. THIS SHOULD NOT HAPPEN AGAIN!

What I am Concerned: "Resuming Acquistions"

While it is indeed true there are bargains out there in the US commercial space, I do not think the REIT should go on an acquistion. Of priority is that it should manage its balance sheet first. PRIME should not be buying US office buildings from its sponsors. Any purchase, utilising leverage without a rights/share placement, will only push the REIT's leverage up.

Shareholders are jaded from collecting little dividend and will not be willing to participate in a rights issue to fund an acquistion. I sincerely hope the management is aware of this. Priority should be given to lower the leverage on the balance sheet, then consider paying a good dividend to improve sentiments so that share prices can go up to 0.6 times book value like what Singapore office REITs have achieved.

Buying more US office commercial buildings should not be done. Yes, many quality US office buildings are now put for sale, but this should not be what PRIME goes after. Furthermore, it should not be a purchase from any of its sponsors. If it's sponsor wants to offload, it should just sell its properties to outside buyers. If it is Keppel Capital, it has its own REIT of KORE to sell to, KORE is holding old assets which is burning so much CAPEX, maybe KORE should just take it to rejuvenate its terrible assets.

Plight of the US Office Market

The amount of US office space vacant is tremendous, many blue democrat states are seeing high vacancy because businesses are leaving due to their high corporate taxes and high number of homelessness which affects security. What makes it worse is that the blue states have much better welfare benefits which are attracting homeless people from other states.

I seriously do not think California will return to its glory days until it cuts its welfare benefits and corporate state tax. If PRIME is successful in driving Tower I occupancy, it should do so and then sell it. One thing i notice in many US office REITs is that the vacancy rates for office buildings in many blue democrat states are higher than that of the Republician states. This is something PRIME should evaluate too. Valuers will be aware of this and abscribe lower values for office buildings in blue states. Sorrento Towers has so far bucked the trend and I think PRIME US REIT too should consider monetising this asset. 

If PRIME REIT starts to incur too much capital expenditures, I do think the REIT should start to offload such buildings as well such as Promende and Tower 909.