• Stay OVERWEIGHT. Monetary Authority of Singapore’s (MAS) proposal to simplify and slightly relax gearing and interest coverage ratio (ICR) requirements is a positive step, and provides greater flexibility and clarity in current high interest rate environment while ensuring prudence. It also gradually shifts the managing appropriate debt levels onus to REIT managers and market mechanisms. If implemented, it will be a slight positive overall for the sector, and mainly benefit a few of the large-cap S-REITs with >40% gearing and smaller overseas REITs.

• A slight relaxation and simplification of leverage requirements. MAS last night published a consultation paper proposing a standard minimum ICR of 1.5x and an aggregate leverage limit of 50% for S-REITs. Currently, S-REITs have a gearing limit of 45% (if the ICR is 2.5x or below) and leverage limit of 50% if the ICR is >2.5x. In addition, MAS’ consultation paper proposes REITs perform and disclose sensitivity analyses on the impact of changes in EBITDA and interest rates on ICRs during their interim results and annual reports. The proposal is currently open to public for views and suggestions until 23 Aug 2024.

• Proposed changes reflective of a higher interest rate era. The sharp rise in interest rates over the last two years has resulted in a double-whammy effect on S-REITs’ capital management. This is as higher financing costs have lowered the REITs’ ICRs while cap rate expansions (used in determining the asset value) have risen – resulting in lower asset value and higher gearing. While a breach in MAS’ limits due to sharp asset devaluations or FX changes is not considered a breach – as these are considered as factors beyond a REIT manager’s control – the REIT would not be allowed to make additional borrowings or enter into further deferred payment arrangements unless the situation is remedied. The overall sector impact – if implemented – is limited, in our view, as the move comes closer to the end of an upcycle. Additionally, most REITs already are well within the leverage limits.

• Beneficiaries would be a few highly geared large-cap and overseas S-REITs. As of June, 13 out of 37 S-REITs have aggregate leverages of >40% and seven have adjusted ICRs below 2.5x (Figure 1). Large-cap Singapore-centric REITs that are likely to see slight positive benefits, in our view, include Suntec REIT and Lendlease Global Commercial REIT. The move is more meaningful for smaller overseas S-REITs – particularly all three US office SREITs, as they have been highly impacted by asset value fluctuations. Other beneficiaries include CapitaLand China Trust, Elite UK REIT, ARA US Hospitality Trust and Lippo Malls Indonesia Trust.

• Top Picks: CapitaLand Ascendas REIT, Keppel REIT, AIMS APAC REIT, and CDL Hospitality Trust. The recent favourable inflation data in the US has shifted market expectations for the US Federal Reserve to make two or more rate cuts by end 2024. This helped S-REITs stage a slight rebound in the last two weeks. More clarity on interest rate trajectory is expected by 4Q24.

Source: RHB Securities Research - 25 Jul 2024