Like China's 3 Red Line Policy, Singapore has its 2 Red Line Policy for REITs. I have been saying it many times so let me repeat it.
If Leverage is more than 45.0%, ICR has to be above 2.5 times
These are the two red lines. In truth, even when REITs exceed 45% leverage and have not taken additional debt, they are able to continue operating without falling foul of MAS's regulations. However, the key is the ICR of 2.5 times (ICR= Interest Coverage Ratio)
Why Overseas REIT Struggle
I do not know if it is risk management or stubborness of REIT managers, but there is a trend where a REIT manager will take loans in the same country where its properties are (the only exception is Capitaland who takes almost everything based on Singapore's SORA).
Both USA, London and Europe have been hiking interest rates to stem inflation. Inflation has remained sticky and because of these, SOFR, LIBOR, EURIBOR have reached highs and will be staying there longer. The problem for many overseas REITs is that many of their loans have not felt the full effect of interest rate hikes yet due of their loan maturity, the time lag effect for it to be reported or that they had done hedging which expires each passing year.
Secondly, MAS's ICR is calculated by the trailing 12 months. As time passes by, the trailing 12 months interest expense gets higher and higher. The result is what we are seeing for many overseas listed REITs financials: ICR keeps going lower and lower. Elitecommercial, PRIME US and UtdHampshire have been reporting higher effective trailing 12 month interest cost while reporting a lower interest coverage ratio. These 3 REITs have reported ICR in the range of 2.7 - 3.3 times.
The Last Red Line- 2.5 times ICR
As narrated, the full effects of higher interest rates have not been reported by most overseas REITs. End 2Q2023 was when most of the rate hikes kick in. With most loans pegged to SOFR and LIBOR, it will take until 2Q2024 for us to know which REITs are drowning.
Overseas REIT are expected to breach the first red line of 45% due to how properties are valued (aka Cap rate expansion). Meeting the 2.5 times ICR is their key concern. REITs have been enquiring with MAS to relax the ICR rules; however MAS has not budged. Without MAS's grace, overseas REITs face the danger of breaching "2.5 times ICR". The alternative would have been switching to Singapore SORA loans where interest are 1.5% or about 20% cheaper; however these REITs have locked themselves into SOFR and LIBOR loans.
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