4Q CY08 report card

4Q earnings steady. S-REITs within our coverage universe generally delivered a fairly steady set of 4Q CY08 results. The results were in line with our expectations, excluding LMIR Trust. CapitaMall Trust and Suntec REIT reported similarly marginal QoQ increases in distribution income of 0.3% and 0.6%, respectively. Frasers Centrepoint Trust experienced some disruptions from asset enhancement works at one mall, but its other properties enjoyed both earnings growth and strong occupancy levels. We believe this quarter’s performance was not evidence of stability or invulnerability but more a function of timing lags. In fact, other indicators like reversionary rents – achieved office rents at Suntec City fell 11% QoQ – point to a different trend.

No big NAV shake-up yet. The same inertia played out in net asset values. Excluding FCT (year end: Sep); the other S-REITs carried out their annual property revaluations in 4Q CY08. CapitaMall Trust registered a marginal 1.9% increase in property values over its last valuation in June 2008. Suntec REIT saw property values fall 7% against its 3Q CY08 revaluation. LMIR Trust also recorded a revaluation deficit, the bulk of which was driven by the adverse SGD-IDR movement over the year. Overall, we feel cap rates used by the independent valuers still do not fully reflect the downwards trend in capital values.

LTV is more important than reported leverage. Because of this timing lag, we believe reported balance sheet figures are under-estimating leverage and over-estimating balance sheet strength. In fact, the market is currently valuing these S-REITs on an average 61% discount to reported NAV. Lenders’ appetite for loan-to-value (LTV) have fallen because of both an expectation of falling capital values and a decreased appetite and capacity for risk.

Maintain NEUTRAL view. In our view, unit prices more than reflect the realities of falling capital values and refinancing risks. We feel the focus is now on how deeply S-REIT earnings will be affected by deteriorating economic conditions – and consequently what is the ‘real’ distribution yield. Meanwhile, we continue to believe S-REITs will need to re-capitalize their balance sheets. The recent equity fund raising announcements from bluechips like Ascendas REIT (raising S$408m) and CapitaMall Trust (S$1.23b) have set the tone for the year. However, the sector is competing for limited resources – for instance, we believe rights issues would need to be underwritten in order to succeed. Once again, the strength of the sponsor (and the size of its stake) will make a difference.

Link – Table

Reit managers fail to get payouts trimmed

Move to cut payout ratio flops as investors demand certainty: sources

The authorities have turned down requests from some Reit managers to reduce the minimum payout ratio to unitholders, BT understands. This is currently set at 90 per cent of the distributable income of a Real Estate Investment Trust (Reit).

The Reit managers have also failed to get a tax holiday on undistributed income, sources say.

Some institutional investors are believed to have recently given feedback to Reits as well as Monetary Authority of Singapore that allowing a reduction in the 90 per cent minimum payout ratio would detract from a fundamental characteristic and key attraction of investing in a Reit – the certainty and stability of income to unitholders.

‘Basically, there would be income volatility once you lower the minimum payout ratio, because the Reit manager will have discretion to decide how much of a Reit’s income it should pay out to unitholders,’ a senior executive of a major Reit manager explains.

‘We have institutional investors who have told us they wouldn’t like Reits’ minimum payout ratios to be lowered from 90 per cent currently. It would defeat the purpose of a Reit.’

BT reported last month that some Reit managers had urged the government to trim the minimum payout to unitholders to as low as 50 per cent of distributable income, while still allowing Reits to enjoy tax concessions.

The proposals to MAS were initially championed by managers of some of the smaller Reits as a way of conserving cash in today’s tight credit environment, to service debt or even try to trim debt.

At first, even managers of a few of the bigger Reits are said to have been sympathetic to such calls, if it could help their smaller counterparts temporarily tide over their cashflow problems, in the interest of helping the S-Reit industry – although these big Reits themselves may have had no intention of lowering their distribution ratios.

However, there has been concern since then that institutional investors, such as superannuation funds, insurance companies and other funds that count on the certainty of a regulated minimum distribution from their investments in the S-Reit sector, may lose confidence and pull out from this market if this rudimentary attraction of Reits disappears.

An executive of a private investment vehicle involved in the S-Reit business said: ‘Investors who went into the Reit market looking for a steady distribution stream would not want the distributions on their units to be halved and used as a backdoor recapitalisation of the Reit.

‘Reit managers may have no choice but to look for ways to raise equity to recapitalise their business. This means holding a general meeting to seek unitholders’ mandate for the issuance of new units for the raising of new capital. The decision must come from the unitholders themselves, and not within the free reign of Reit managers, or indeed the MAS.’

The authorities are also said to have decided against granting a tax holiday on any undistributed amount of a Reit’s income, even if this stays at the current maximum 10 per cent of a Reit’s income.

S-Reits have to pay out at least 90 per cent of their distributable income to unitholders to enjoy tax transparency, which means exemption from paying corporate tax at the Reit level on the portion of income they distribute.

Some Reit managers had wanted the government to continue according them tax transparency, even at the lower payout ratio. A few even suggested MAS go a step further and grant Reits a tax holiday on the income that they withhold from distribution.

These suggestions had drawn flak from some quarters. A major question raised was why Reits should continue to enjoy exemption of corporate tax at vehicle level, if they trimmed their distribution payout ratios, when many other listed companies also return a chunk of their profits to shareholders, but still have to pay corporate taxes.

Reits seek cut in payout to as low as 50%

They are also calling for a tax holiday for distributable income that is not paid out

Some real estate investment trust (Reit) managers have urged the government to reduce the minimum payout ratio to Reit unitholders to as low as 50 per cent, from 90 per cent now, while still allowing the trusts to enjoy tax concessions.

And they have even proposed a tax holiday on distributable income that they do not pay out.

The suggestions are aimed at helping Reits conserve cash to get them through today’s tight credit market conditions, BT understands.

Reits have to pay out at least 90 per cent of their distributable income to unitholders to enjoy tax transparency on the amount that they pay out. For example, if a Reit makes $100 million of distributable income in a year and pays out $90 million to unitholders, it does not pay corporate tax of 18 per cent at the Reit/vehicle level on the $90 million.

However, it has to pay tax on the $10 million that it withholds. If a Reit distributes all $100 million, then it does not pay any tax on its income for the year.

Instead, Reit unitholders are liable to be taxed on the distributions that they receive, depending on their profile. This ranges from zero tax for individual investors regardless of nationality, to 10 per cent for foreign corporate/institutional investors and 18 per cent for local corporate investors.

Reit managers have been giving a variety of feedback to the Monetary Authority of Singapore. One request is to reduce the minimum payout ratio from 90 per cent of distributable income to anything from 50 to 75 per cent, BT believes.

The Reits also want MAS to continue according them tax transparency, that is, to keep exempting them from paying corporate tax on the portion of income that they pay unitholders, even at a lower payout ratio. Some are even urging MAS to go a step further and grant Reits a tax holiday on the income that they withhold from distribution.

Market watchers say that this would lead to a substantial loss of tax revenue. To address this concern, some Reit managers have suggested that the tax holiday on income that is not distributed could be limited to, say, two years to help Reits ride out the current tough environment. Agreeing, an analyst suggested that Reits could be required to pay back taxes after the two-year period expires. By then, hopefully, things will be better.

MAS is understood to have sought the views of a gamut of parties – including Reit managers, bankers, lawyers and even unitholders – on the topic.

Among the issues is fairness in tax treatment in relation to other listed and non-listed entities. ‘Why should Reits continue to enjoy exemption of corporate tax at the vehicle level if their distribution payout ratios fall, when many other listed companies also distribute a chunk of their profits to shareholders but still have to pay corporate taxes?’ asked an industry observer.

Some Reit unitholders may not be happy with a lower distribution payout ratio, as it will create more uncertainty about returns. This could be a bugbear, especially for corporate investors such as funds and insurance companies that have obligations to achieve target returns for their own investors and policy holders.

The counter-argument is that, in times like these, the survival of Reits must be paramount. As OCBC Investment Research said this week: ‘While this may create income uncertainty for investors, we think the first priority is to ensure Reit survival and dividend sustainability. We note that a minimal cut from 90 per cent to say, a 75 per cent payout ratio requirement, is not a silver bullet for Singapore Reits with significant liquidity issues. But Reit managers may like to have as much flexibility and (cash) ammunition as they can get in the current environment.’

MAS gives Reits a New Year gift

Refinancing of maturing debt facilitated; clarity on leverage ratios

Reit managers here have been given more breathing space on borrowing limits by the Monetary Authority of Singapore (MAS), which has clarified how downward revaluations of properties should be treated.

Basically, MAS has said that Reits need not worry if their leverage has increased because properties have been revalued and are now worth less.

Under MAS’s Property Fund Guidelines, an S-Reit’s total borrowings and deferred payments (the ‘aggregate leverage’) should not exceed 35 per cent of its deposited property. This maximum limit is set at a higher 60 per cent if the Reit obtains a credit rating and publicises it.

In a circular to Reit managers and trustees earlier this month, MAS confirmed that if the aggregate leverage has gone up because of a decline in property values, it will not amount to a breach of leverage limits. MAS also made the important point that refinancing of existing debt by a Reit is not to be construed as incurring additional borrowings.

‘So if at the point of refinancing, a Reit has to revalue its assets (which lenders will require), and so long as the refinancing is of existing debt, MAS will not consider this as additional borrowing and hence the Reit will not be in breach of the statutory leverage limit,’ says Giam Lay Hoon, group general counsel of Oxley Capital Group, which owns a stake in the manager of Cambridge Industrial Trust.

MAS also said that it will permit Reits to raise debt for refinancing purposes earlier than the actual maturity of the debt to be refinanced, without having to include such funds raised in the aggregate leverage limit. However, this is ‘provided that the funds are set aside solely for the purpose of repaying the maturing debt’.

‘The trustee must place these funds in a separate trust account which shall be drawn on only to repay the maturing debt,’ MAS said in its circular.

Oxley Capital’s Ms Giam welcomed MAS’s responsiveness to tight credit market conditions. The CFO of a Reit manager told BT that the MAS clarifications would ‘give some breathing space for some Reit managers with high gearing and with properties in danger of being substantially depreciated’.

This, he said, would ease the pressure on these Reits to recapitalise through raising fresh equity and reduce pressure on the unit price of these Reits.

‘However, ratings agencies will continue to be nervous about property depreciation as that may reflect sliding rents and occupancies and a rise in tenant-default rates,’ he added.

Stan Ho, Fitch Ratings’ senior director and head of Non-Japan Asia structured finance, stressed that ‘any downward revaluation of the underlying property would raise the loan-to-valuation ratios as far as banks lending to Reits are concerned, and this would need to be considered in our ratings for Singapore Reits’.

Kathleen Lee, vice-president and senior analyst at Moody’s Singapore, also pointed out that while a downward revaluation may not breach MAS’s statutory aggregate leverage limit for S-Reits, ‘lenders to Reits can set their own covenants and a downward revaluation could trigger a breach of some of these covenants and that could also lead to a re-rating of the Reit’.

In a separate development, MAS is understood to have sought feedback recently on whether the current minimum distribution payout ratio for S-Reits should be lowered, from 90 per cent of distributable income currently to, say, 75-80 per cent. Some Reit managers are lobbying for the cut. ‘Cash is a premium today and Reits may want to conserve their cash for a host of reasons, including servicing loans, reducing debt or just as general ammunition,’ an industry player said.

However, a rival disagreed, arguing ‘this would go against the fundamentals of why the S-Reit market was created’.

Reits have a high degree of transparency and investors have a high level of certainty of distributions from Reits. ‘So when you give more flexibility to the Reit manager in terms of how much of distributable income it has to pay to unit holders, it creates more uncertainty for the investor. Investors like clarity,’ he added.