Current panic sell off is quite similar to 2008 GFC. Investors are fearful that Reit may not able to refinance. In my opinion, Interest Cover ratio > 4X and low gearing are very important. Read on...
An exerpt from Bobby Jayararam REIT. book....
Panic sell-down (2008-early 2009).
By late 2007, the sub-prime crisis in the United States had started and tremors were being felt across the world. The capital markets where companies go to raise financing were frozen as no one wanted to lend; everyone’s focus was on conserving cash. Enough has been written about this financial crisis and I will not spend time rehashing all the events. What is important though is to understand that the financial panic had a particularly strong effect on leveraged investments such as REITs. Let us understand why.
The lifeblood of a REIT is the ability to produce financing at reasonable cost. Hence, any turbulence in the credit market will have a strong impact on the financing ability of REITs and in a worst case scenario (if the liquidation value of its properties is unable to cover the loan cost) may lead to bankruptcy.
Singapore REITs had also made heavy use of CMBS loans during the boom period from 2005 to 2007.
This market virtually shut down during the crisis, and the REITs had to approach banks to refinance the maturing CMBS loans.
Other than the financing issue, the financial crisis was gradually starting to affect the real economy and lead to a full-blown recession. People were starting to spend less, companies were downsizing and manufacturers were slowing production. All of this directly affected the business of REITs. If customers shop less in a mall, the shops will have difficulty paying their rentals and retail REITs such CMT and FCT would face an increase in bad debts when tenants are not able to pay their rentals on time. If companies downsize heavily, there will be fewer tenants for office space and office REITs such as CCT will face high vacancy rates.
To sum up, REITs were facing the perfect storm. They were confronted with the risk of not being able to refinance their loans on maturity plus the likelihood of slowing revenues from their properties which would put at risk the REITs’ ability to service their debts and pay dividends t unit holders. There were no precedents for such market conditions and panicky investors were starting to question the fundamental business model of REITs and whether they would survive the crisis.
By early 2009, the market was pricing in a bankruptcy for many REITs and investors were taking action by hitting the “sell” button hard! The “great Singapore REIT sale” had begun with many excellent REITs selling at double-digit yields (the lower the share price, the higher the yield).
The sale was, however, short-lived. By mid-2009, instead of the bankruptcies bad debts and fire sales of assets predicted by doomsayers, the REITs actually mounted a fierce rally! S-REITs proved much more resilient than was initially thought. During the crisis, not a single major S-REIT suspended it dividend payments (SaizenREIT, a Japan-focused REIT did temporarily suspend its dividend payments). There were no forced liquidations or bankruptcies rather. Why?
The most important factor was simply the quality of the assets. Many REITs had high-quality properties in good locations that had a proven ability to generate cash through good and bad times. Mall, office and industrial tenants had experienced several booms and bust cycles and knew the right measured to take to weather the crisis. The REITs were also highly proactive in supporting their tenants with appropriate marketing efforts. As a result, no tenant defaulted on rentals, nor were there high vacancy rates or premature lease cancellations.
Secondly, the REITs had acted swiftly to shore up their balance sheets and reduce gearing. This was done through raising equity via right issues and bank loans. Many investors were not happy with the dilutive nature of some of these issues but immediate disaster was averted.
The market had also underestimated the ability of the REITs to refinance their loans at reasonable interest rates during the crisis. CCT and CDL, two REITs heavily exposed to the deteriorating economic conditions, refinanced $580 million and $350 million on reasonable terms in the first quarter of 2009, during the depths of the financial crisis. The banks appreciated the resilient earnings power of the REITs’ assets and the strong sponsors of these REITs provided additional assurance.
All of the above meant that while many REITs lost more than 70% of their market value during the sell-down, their businesses were running pretty much as usual. Occupancies were stable and tenants were paying their rentals on time. Hospitality REITs such as CDL suffered from temporary reduced tourist arrivals but had no issues servicing their debt (they generated enough cash from their businesses to make interest payments to the banks or bond holders). Most importantly for investors, all REITs continued to pay dividends on time.
This indeed speaks to the strength of the assets of most REITs. Other than having to undertake dilutive right issues, the REITs came through the severe crisis in fairly good condition. Their share prices had been hit, but not their operating earnings and ability to pay dividends. Investors should do well to remember this.
There is no denying that the crisis was a great learning experience for both investors and the REITs.
Investors that were banking on the stability of REITs versus other equities were shocked to see REITs fall even harder than the rest of the market. Between June 2007 and December 2008, the REITs index fell more than 66%, as opposed to a 50% drop in the STI. A major reason for the severe fall was that in 2007, many REITs had simply become too overvalued (as described in the 2002-2007 bull cycles). Investors also learned to differentiate between different REITs and were awakened to the 21
important of resilient assets, financially strong sponsors and competent REIT managers.
It is hoped that they also learned not to panic in the next crisis. Despite the sharp share price drops, investors who had held on to good REITs and did sell during the crisis sailed through just fine as they collected dividends throughout the crisis period.
Meanwhile, the REIT managers learned their own lessons about leverage, the excessive use of short-term financing and the need to have diverse sources of funding. Once more they were reminded of the need to exercise restraint in a booming property market and not overpay for acquisitions and extrapolate current rentals into the future.
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