Learning about REITs Series Part 1 – Are Singapore REITs defensive?

Since the Singapore REITs sector was incepted in July 2002 with the listing of CapitaMall Trust, the sector has grown by leap and bounds over the last nine years. There are now currently 34 REITs listed in Singapore, ranging from retail (i.e. shopping malls), office, industrial, hospitality (i.e. hotels and serviced residences) to healthcare REITs. Hence, Singapore REITs sector is second largest in Asia, just behind the Japan REITs sector.
We believe the rise in popularity of Singapore REITs over the last nine years have to do with the advantages of using REITs as investment vehicles to gain exposure to investment properties. One of the main advantages of REITs is their tax-efficient status.

Singapore REITs do not have to pay income taxes at the corporate level (i.e. tax pass-through), and for individual shareholders they are also exempted from paying income tax on the dividends they received from Singapore REITs (although corporate shareholders of Singapore REITs are not tax exempted). In addition, Singapore REITs allow investors to diversify their investment properties exposure as REITs generally invest in a basket of investment properties. And last but not least, Singapore REITs have to pay at least 90% of their income available for distribution as dividends, thus making them high dividend yielding stocks. This, coupled with the fact that most REITs tend to have relatively more stable income streams, are also the reasons why the Singapore REITs sector is perceived to be a defensive sector in the Singapore equity market.

Not all REITs are created equal.

However, in our view, not all REITs are created equal and some REITs are more defensive than others. Based on past experience, retail and industrial rentals tend to be relatively more stable and resilient in past downturns than office rentals and hotel room rates, which means retail and industrial REITs tends to be relatively more defensive than their office and hotel peers. This may be because retail properties tend to be more location-specific and thus less commoditized. For example, shopping malls located near MRT stations do better in terms of shopper volume and thus tenant demand than shopping malls located further away from MRT stations (even if the rentals are much lower). Suburban shopping malls also tend to cater more to tenants that provide basic staple goods (e.g. supermarkets) that are less economically sensitive. For industrial properties, their tenancy contracts tend to be longer than the usual three year period, thus giving them more rental stability.

On the other hand, office rentals tend to be more economically sensitive as shown in past downturns. For prime offices, one of their major tenant sources is the financial institutions sector, which tends to be significantly exposed to the broader economic cycle. In the case of hotels, their rental incomes tend to be less stable due to fluctuating occupancy rates.

Defensive as long as there is no credit crunch.

The REIT business model also relies significantly on the availability of credit as REITs do not retain much of their incomes and thus need to periodically tap the banks or capital markets to refinance their debts. And in events when credit is unavailable, there could be a real risk that some REITs may be unable to refinance their debts and their business models could be disrupted. This was what happened during the credit crunch in 2008 and 2009, when a number of small REITs with high gearings were in danger of defaulting on their debts.

This explains why Singapore REITs, despite their high dividend yields, did not display their perceived defensive characteristics and generally fell as much as the broad equity market in 2008 and early 2009.
Singapore REITs have generally learnt their lessons since then. They have actively diversified their funding sources and currently hold lower debts levels than in 2008. Credit financing conditions are also currently normal with REITs still been able to get debt refinancing from different sources. However,if a credit crunch happens perhaps due to a worsening of the EU debt crisis, it could still significantly harm Singapore REIT’s’s defences.

Parentage matters.

To end off, in such a credit crunch scenario, investors should be better off holding on to the big REITs that have strong corporate parents. Mapletree Investments, Ascendas Group, Capitaland, Keppel Land, City Developments and Fraser & Neave are the main Singaporean sponsors and parents to a number of REITs in Singapore. Strong corporate parents are advantageous if credit crunch occurs as banks may only selectively provide financing to REITs that are deemed safer from a credit prespective, which means REITs that have strong corporate parents. In addition, such strong corporate parents could also step in to provide equity financing in the event if credit is really unavailable.