Following from my previous post which said the main threat REIT faces is the Interest Coverage Ratio, it is likely both PRIME US REIT and Keppel Pacific will not go the route of raising cash from now until June 2024.
Here's why
While devaluation of their US properties will occur, the magnitude of the decrease are unlikely to cause a breach above the 60% leverage mark which would trigger an increase in financing. This is what happened to Manulife US REIT where a massive devaluation caused the REIT to fall afoul of its debt conditions which resulted in marked up interest rates.
For PRIME and Keppel Pacific to go to the above scenario, their properties value must be devalued by 28% and 35% respectively. Given that there have been no sudden news of tenants vacating, I find such a magnitude in devaluation unlikely to happen. Therefore, these 2 US REITs are safe for now
What Happens after July 2024
For PRIME US REIT, 64% of its debt will be due in July 2024. Given it is in the US commercial space which is viewed as a terrible state, it is likely PRIME US's loan will be reset and renewed at a higher spread from the SOFR rate. This mean it's interest coverage ratio may go below 2.5 times or new debt conditions may be imposed which will make the REIT operations difficult.
Therefore, in my view, the REIT should start to be prudent and reduce its payout ratio from 100% to 90%. It should start accumulating cash to renew its debt facilites at a lower amount. This way, even if the interest rates increase, the loan quantum is smaller and thus it does not breach below the 2.5 times interest coverage ratio.
For Keppel Pacific, it seems to be in a very strong financial standing with a staggered debt profile. Hence, my view a cash call on Keppel Pacific end is unlikely. Keppel REIT seems to have been unfairly hit down and I do feel it is going to keep paying out US 3-4 cents dividends per year. This will make it a 15% dividend yielder for investors.
Devaluation is not just due to the debt that the REIT holds. It can also happen due to rising interest rates affecting the discounted cash flow value of the property. When interest rates are high, the future rentals are worth much less in today's money and that reduces the property's current value. This is one of the reasons why most rental-generating commercial REITS property are being re-valued lowered and will continue with downtrend if interest rates continue to go higher.
ReplyDeleteRelated to this is the risk-free returns bar is being raised (10-year US bonds interest going higher) so investors buying REITS want a premium above that of risk-free returns - hence, REITS share price is hammered down to give higher yield % based on the lower price.