The recent market rout and subsequent bear market have left REIT investors battered and bruised.
Investors cannot be blamed for questioning if distributions are going to decline drastically due to the COVID-19 pandemic.
Many REITs are forecasting a sharp decline in rental income, both from a plunge in visitor arrivals (for hospitality REITs) to tenants seeking rent relief (for retail REITs).
To help REITs navigate these challenges, the Ministry of Finance (MOF), Inland Revenue Authority of Singapore (IRAS) and Monetary Authority of Singapore (MAS) have announced a set of new measures to provide REITs with greater flexibility to manage their cash flows.
Here is a look at three measures and how they will impact REITs.
Extension of the permissible period for distribution of taxable income
REITs have to pay out at least 90% of their earnings per share (EPS) to qualify for tax transparency. Under the tax transparency treatment, all distributions to unit-holders are not taxed.
MOF and IRAS will extend the timeline for REITs to distribute at least 90% of their income from three months to 12 months for the fiscal year 2020.
This move means that REITs have up to a year after their fiscal year-end to satisfy the condition of the 90% distribution.
To take an example, assume that a REIT generates a total EPS of S$0.10 for the fiscal year 2020.
To qualify for tax transparency, the REIT will have to distribute at least S$0.09 to unit-holders.
However, REITs can pay their distributions either quarterly or half-yearly.
The flexibility of the new measure means that REITs can elect to withhold or reduce the distribution per unit (DPU) in the short-term to conserve cash during the pandemic.
Instead, the REIT could choose to pay S$0.01 in the first three quarters totalling S$0.03 and pay the remaining S$0.06 in the fourth quarter.
This adjustment allows the REIT manager to manage his cash flows much better by retaining the bulk of rental income as a buffer.
IRAS will provide further details of this change by early May 2020.
Higher leverage limit
MAS will also raise the leverage limits for REITs from the current 45%, to 50% with immediate effect.
REITs that face a fall in value in their total asset base will have some leeway to comply with regulations.
As a primer, the REIT’s leverage is computed by its total debt divided by its total asset base.
During a crisis, the value of the assets could be marked down temporarily as independent valuers base the asset’s value from rental rates.
Rentals will almost surely come under pressure due to a supply glut as tenants vacate premises under financial stress.
If asset values plummet while the gross debt remains constant, REITs may risk breaching the old regulatory limit of 45%.
This timely move by MAS ensures that REITs will still be able to comply with leverage requirements and not have to rely on urgent fundraising through the capital markets.
Deferral of interest coverage requirement
Before the pandemic, MAS had proposed to require REITs to have a minimum interest coverage ratio (ICR) of 2.5 times before they are allowed to raise their leverage beyond the 45% threshold.
The implementation of this new requirement will now be deferred to 1 January 2022.
As a recap, the ICR is computed as the operating profit for the REIT divided by its interest expense.
This measures the ability of the REIT to effectively service the interest payments on its debt load.
However, MAS does require REITs to disclose their leverage ratios and ICR in both annual reports and interim financial statements.
Get Smart: REITs have been thrown a valuable lifeline
These announcements must be music to a REIT investor’s ears.
A valuable lifeline has been thrown to REITs that provides them with a better chance to manage their leverage and cash flow.
Investors need to be prepared for lower distributions in the short-term, though, as REITs may need to cut back on DPU to conserve cash.
However, these measures will go a long way to helping REITs to survive over the long-term.
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