Singapore REITs debt levels surge despite robust operations

What could be the risks?

According to Fitch Ratings' special report on SREITs, the availability of low-cost debt and the demand for dividend distributions in an environment of falling asset yields is leading to an increasing use of debt in Singapore Real Estate Investment Trust (SREIT) funding mixes. 

The increasing leverage of SREITs poses several risks to the sector, including refinancing risk and exposure to interest-rate shocks.

The competition for assets that results from the use of leverage will put downward pressure on underlying asset yields and further exacerbate this trend.

Here's more from Fitch Ratings:

Short-Dated Lease Maturities: A structural feature of the commercial property market in Singapore is the short-dated maturity of leases.

This feature poses a challenge to the funding options available to SREITS. SREITS have, typically, resorted to short-term borrowings to manage asset/liability mismatches.

Interest-Rate Sensitivity: Over the past six years, SREIT funding costs have benefited from falling short-term rates. However, in a normalised interest scenario, coverage metrics appear weak.

In the event of a sudden move to higher interest rates, the gap between asset yields and interest rates would widen owing to the much slower pace at which asset yields are prone to self-correct.

In a rising-interest-rate environment, SRETs may be able to switch to secured borrowings or securitisation given that the majority of SREIT assets are unencumbered.

Alternatively, SREITs may be required to resort to asset disposals or equity raisings in order to provide sufficient coverage of fixed charges

Weak Liquidity Profiles: With reliance on short term bank debt, the liquidity profile of the SREIT sector is generally weak. Fitch Ratings expects the asset/liability duration mismatch to persist across the SREIT sector over the medium term.

A shift towards capital market-supplied debt, which has longer duration that bank debt, is yet to gain momentum and remains a longer-term prospect.