Simplifying S-REITs: MAS New Rules Boost Transparency

The Monetary Authority of Singapore (MAS) is proposing to simplify leverage requirements for REITs. This will subject all of them to the same minimum interest coverage ratio (ICR) threshold of 1.5 times and an aggregate leverage limit of 50 per cent.

Ever felt like decoding S-REIT financials was like trying to solve a puzzle blindfolded?

The MAS seems to have heard our collective sighs and is proposing some game-changing simplifications to REIT leverage requirements.

Personally, I love the proposal (see The Straits Times coverage here). I feel that this is definitely a move in the right direction, which can help investors better understand the financial status of REITs.

You can read the Consultation Paper on Proposed Amendments to the Leverage Requirements for REITs here.

What The MAS Proposal For REITs Means

Before we proceed, it is important to understand that the leverage limit and ICR serve different objectives but work together to indicate a REIT’s financial strength.

• The leverage limit (also known as gearing) seeks to ensure that a REIT manages its debt level and is well-capitalised
• The interest coverage ratio measures the debt-servicing ability of a REIT

Now that we understand these two frequently used terms, here are 3 points summarizing the proposals in the consultation paper by MAS.

1. Simplified leverage requirements for REITs:

• All REITs are to maintain a minimum Interest Coverage Ratio of 1.5x
• Single aggregate leverage limit of 50% for all REITs

2. New disclosure requirements

• REITs to perform and disclose sensitivity analyses on the impact of changes in EBITDA and interest rates on their abilities to service their loans
• To be included in interim financial results and annual reports

3. Rationale for changes

• To simplify existing requirements while maintaining prudent borrowing practices
• To provide investors with better information on how market conditions could affect a REIT’s credit profile

The ICR refers to the trailing 12 months’ earnings before interest, tax, depreciation and amortisation (“EBITDA”, excluding effects of any fair value changes of derivatives and investment properties and foreign exchange translation) divided by the trailing 12 months’ interest expense, borrowing-related fees and distributions on hybrid securities.

Why is this important? REITs such as Lendlease REIT have issued perpetual securities that are not reflected in the leverage limit but affects the ICR.

This also means that the current requirement for REITs to have a minimum ICR of 2.5 times before their aggregate leverage may exceed 45% (up to a maximum of 50%) will be removed.

The Current REITs Situation & Background Information

Back in 2020, the leverage limit was raised from 45% to 50% to give REITs greater flexibility in managing their capital structure.

To increase their leverage beyond the prevailing 45% limit, a new minimum ICR of 2.5x was supposed to be implemented.

Due to the COVID-19 pandemic, this minimum ICR requirement was deferred to January 2022.

As of right now,

• Regulatory gearing limit of 50% for REITs
• To increase aggregate leverage limit beyond 45% to 50% → minimum ICR 2.5x is required

Example: Lendlease REIT Presentation Slides

When it comes to understanding REITs’ debt profiles, I usually try to obtain their latest business or financial presentation deck.

This was precisely what I did when I wrote about Lendlease REIT to learn more about their debt situation.

Taking a look at their business update from May 2024, it would appear to the casual reader that Lendlease REIT’s interest coverage ratio is 3.4x.

Remember that we are concerned with the fact that the interest coverage ratio measures a REIT’s ability to meet its interest payments.

However, some investors find it confusing that the interest coverage ratio is calculated differently for the Debt Agreement vs. Property Funds Appendix of the Code on Collective Investment Schemes.

• Debt agreement interest coverage ratio
  • This is the ratio of a REIT’s earnings before interest and taxes (EBIT) to its interest expenses.
  • It is used to measure a REIT’s ability to meet its interest payments.
• Property funds appendix interest coverage ratio
  • This is the ratio of a REIT’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to its interest expenses.
  • It is a more comprehensive measure of a REIT’s ability to meet its interest payments than the debt agreement interest coverage ratio, as it takes into account depreciation and amortization expenses.

Remember, the higher the ratio (which is good), the more likely a REIT is to be able to meet its interest payments.

Let us take a closer look at the small print in the screenshot above.

The ICR as of 31 March 2024 is 3.4x, in accordance with requirements in its debt agreements.

The ICR as of 31 March 2024 is 2.3x, in accordance with the Property Funds Appendix of the Code on Collective Investment Schemes.

The adjusted ICR as of 31 March 2024 is 1.8x, in accordance with the Property Funds Appendix of the Code on Collective Investment Schemes.

The adjusted Interest Coverage Ratio takes into account perpetual securities which Lendlease REIT has issued.

As you can see, this kind of presentation can cause considerable confusion to investors who are trying to decipher the financial information available because the ICR that is used to determine the leverage limit of Lendlease REIT is 1.8x (small print) instead of 3.4x (big print), i.e., the Lendlease REIT leverage limit is 45% now.

With the proposed change, REITs will no longer be able to mask their debt situation within the fine print.

Summary

The Monetary Authority of Singapore’s proposed changes to S-REIT leverage requirements aim to simplify regulations and increase investor transparency. These changes could significantly impact how we evaluate and invest in REITs.

1. Simplified leverage rules: All REITs will need to maintain a minimum Interest Coverage Ratio of 1.5x and will be subject to a single aggregate leverage limit of 50%.
2. Enhanced transparency: REITs will be required to disclose sensitivity analyses, showing how changes in EBITDA and interest rates could affect their ability to service loans.
3. Easier comparison: The new standardized requirements will make it simpler for investors to compare different REITs and assess their financial health at a glance without having to make special considerations for REITs that have issued hybrid securities.

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