Are S'pore REITs defensive?

16 September 2011
Tan Chin Keong

Since the listing of the first real estate investment trust (REIT) in Singapore in July 2002, the sector has grown by leaps and bounds. The Singapore Exchange now lists 23 REITs with underlying properties varying from retail, offices and industrial to hospitality and healthcare. This has made Singapore's REIT sector the second-largest in Asia, after Japan's.

REITs are popular because of the many advantages they offer. For one, they allow investors to diversify their property exposure, as REITs generally hold a basket of investment properties.

Another main attraction is their tax-efficient status. As tax pass-through entities, Singapore REITs do not pay income taxes at the corporate level. Individual shareholders are also exempt from paying income tax on the dividends they receive, although corporate shareholders are not.

In addition, REITs pay at least 90 per cent of their income available for distribution as dividends, making them high-dividend-yielding stocks. These, coupled with the fact that most REITs tend to have relatively stable income streams, are also the reasons why they are perceived as a defensive sector in the Singapore stock market.


Not all REITs are created equal

Give the number of REITs available, how does an investor decide which to choose?

In my view, not all REITs are created equal and some are more defensive than others. Based on experience, shopping mall and industrial property rentals tend to be more stable and resilient in downturns than office rentals and hotel-room rates, which means retail and industrial REITs tend to be more defensive than their office and hospitality peers.

This may be because retail properties tend to be more location-specific and thus less commoditised. For example, shopping malls near MRT stations do relatively better in terms of shopper traffic - and thus tenant demand - than those farther away from the stations even if the rentals for the latter are much lower.

Meanwhile, suburban shopping malls tend to cater more to tenants such as supermarkets, which are less economically sensitive because they provide staple goods. For industrial properties, their tenancy contracts are generally longer than the usual three-year period, giving them more rental stability.

In contrast, office rentals tend to be more economically sensitive, as seen from past downturns. One of the major tenants of prime offices, for example, is the financial sector, which is significantly exposed to the broader economic cycle. For hotels, rental incomes are relatively less stable, as they are not locked in and tend to fluctuate with daily occupancy rates.


Defensive as long as there is no credit crunch

Another important consideration is that the REIT business model relies significantly on the availability of credit. REITs do not retain much of their incomes and thus need to periodically tap the banks or the capital markets to refinance their debt.

In times when credit is unavailable, the inability to refinance becomes a real risk for some REITs. This is what happened during the credit crunch of 2008-09, when a number of small, highly-leveraged REITs came close to defaulting on their debts. This also helps explain why Singapore REITs, despite their high dividend yields, did not display their defensive characteristics and generally fell as much as the broad equity market in 2008 and early 2009.

That said, Singapore REITs have learnt their lessons. In general, they have actively diversified their funding sources and now hold lower debts levels than in 2008. Credit conditions are also currently normal and REITs are able to obtain debt refinancing from different sources.


Parentage matters

However, a new credit crunch - if it materialises, perhaps due to a worsening of the euro zone debt crisis - could significantly dent the defensive characteristics of Singapore REITs. In such a scenario, investors are likely to be better off holding the larger REITs with strong corporate parents.

The advantage of having strong parentage is that during a credit crunch, banks may only provide financing to REITs that are deemed safer from a credit perspective, which usually means those with strong corporate parents. Furthermore, strong parents could step in to provide equity financing if credit is unavailable, thus providing some stability to the REIT business model.


Tan Chin Keong is an analyst at UBS Wealth Management Research.