Which S-REIT could face a cashflow problem?

It has been a nightmarish two weeks for Real Estate Investment Trust (REIT) investors in Singapore's stock market.

Almost every S-REIT was massively sold down, with many losing more than 50 per cent of their value. Investors who invested on margin were hit especially hard as their losses were amplified and they were forced into selling off positions at a loss.

Investors of REIT-ETFs also reportedly rushed to the exits, further exacerbating the situation.

It does not help that global economic activity has slowed down significantly because of Covid-19. Although most REITs will likely be able to weather this short-term storm, there are some that could face difficulties.

Last week, I published Which S-REIT Can Survive This Market Meltdown? In it, I said that some REITs may face a cashflow crisis if their tenants default on rent.

This can lead to a vicious cycle of REITs struggling to pay their interest and end up having to sell assets or raise capital through rights offerings or private placements.

REITs that have a concentrated tenant base, high-interest expense, and less headroom to take on more debt (the regulatory ceiling is a 45 per cent debt-to-asset ratio) are more at risk of a cashflow problem.

In this article, I will highlight some REITs that sport some of these unwanted characteristics.

High tenant concentration

REITs most at risk are those with tenants that cannot pay up their rent. Having a high tenant concentration means that the loss of revenue will be massive if the major tenant defaults.

Below are some S-REITs that have relatively high tenant concentration. Do note that this is not an exhaustive list, they are just some REITs that I have studied:

• First REIT (SGX: AW9U): The healthcare REIT derived around 82 per cent of its rental income from PT Lippo Karawaci Tbk and its subsidiaries in 2018.
• EC World REIT (SGX: BWCU): The E-commerce and specialised logistics REIT owns China assets and is dependent on two major tenants: Hangzhou Fu Gang Supply Chain Co Ltd and Forchn Holdings Group Ltd. Combined, the two tenants contributed 67.4 per cent of the REIT's total rental income in 2018.
• Elite Commercial REIT (SGX: MXNU): The UK-focused REIT rents practically its entire portfolio to the UK government.

High tenant concentration is risky but it also depends on the type of tenant that the REIT is renting to.

In First REIT's case, its assets are healthcare properties such as hospitals and nursing homes. Business in healthcare properties should continue as usual during the Covid-19 pandemic, so the tenants will most likely have the means to pay its rent.

Elite Commercial REIT's tenant is the UK government, which will almost certainly have the means to cover its obligations.

So, while it is important to think about tenant concentration, it is equally important to judge the likelihood of the main tenant defaulting.

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High gearing

REITs that have high gearing will have little debt headroom to take on more borrowings if the need arises.

Below are some REITs that have gearing ratios that are close to the 45 per cent regulatory ceiling.

• ESR-REIT (SGX: J91U): With a gearing ratio of 41.5 per cent at end-2019, the industrial REIT is one of the highest geared REITs in Singapore.
• Cache Logistics Trust (SGX: K2LU): The logistics REIT has a gearing of 40.1 per cent as of 31 December 2019.
• Ascendas REIT (SGX: A17U): As of December 2019, the largest REIT in Singapore by market cap had a gearing ratio of 35.1 per cent.

Again this is not an exhaustive list and not all REITs with a high gearing ratio will face default.

However, REITs that have high gearing have less financial flexibility and may need to tap into the equity markets to raise money in the unlikely situation of a cashflow crisis. Tapping on the equity markets could mean dilution for a REIT's existing unitholders.

Low interest coverage

For a simple but not exact definition, the interest coverage ratio compares a REIT's interest expense against its net property income. A high interest coverage ratio means that the REIT is able to service its interest expense easily with its income.

In a time of crisis, it is important that a REIT's rental income can at least cover its interest expense to tide things over. Defaulting on debt obligations can hurt a REIT's credit rating and ability to negotiate lower interest rates in the future.

Here are some S-REITs with a low interest coverage ratio (again, it's not an exhaustive list):

• ESR-REIT: With its high gearing, ESR-REIT's interest expense is naturally high compared to its rental income. As of Dec 31, 2019, it had an interest coverage ratio of 3.7 times.
• EC World REIT: China-focused REITs traditionally have a higher cost of debt so its no surprise that EC World REIT has a low interest coverage ratio of just 2.5 times:
• Ascendas India Trust (SGX: CY6U): Technically a business trust, Ascendas India Trust owns IT-related and logistics properties in India. It has an interest coverage ratio of 3.6 times.

The REITs above have low interest cover so a drop in rental income may result in their inability to pay their interest expense.

ALSO READ: Top 10 Singapore REITs that made you money if you invested from their IPOs

Wait and see…

The above-mentioned REITs have some of the unwanted characteristics that make them susceptible to cash flow issues. However, it is not clear whether they will end up facing tenant defaults.

Ultimately, whether the REIT can weather the storm comes down to if their tenants can meet their rental obligations. So far, none of the REITs have made any announcements of tenant defaults, so it is best not to panic yet.

As a REIT investor, I have not sold any of my positions and I believe that most of the REITs in my portfolio will be able to weather this storm.

For the time being, I am taking a wait-and-see approach but will be keeping a close eye for any announcements or earnings updates.

This article was first published in The Good Investors. All content is displayed for general information purposes only and does not constitute professional financial advice.