Why Looking For REITs With Low Leverage Is Important
REITs have been Singapore’s stock market darlings. Over the last five years, the total return for REITs was around 10% per year, handsomely outperforming the market as a whole.
But, not all REITs in Singapore have performed so well. Some have lagged behind in terms of dividends and capital appreciation. So, what makes some REITs stand out from the rest?
In a previous article, I talked about three red flags investors should be wary of when investing in REITs. In this article, I will take a look at what I feel is one of the most important metrics to look out for in a REIT: The gearing ratio.
The key ratio
The gearing ratio tells us how much debt a REIT has incurred in relation to its total assets. The higher the ratio, the more debt the REIT has incurred, leaving less room to further increase its asset base with debt in the future.
In Singapore, REITs have to adhere to regulatory guidelines of having a gearing ratio of not more than 45%. This is to ensure that REITs do not take on too much debt, which may cause them to be exposed to the risk of default.
Room for growth
So why is having a low gearing so important? For one, REITs that have less debt will be able to more easily grow their portfolio in the future by increasing their borrowings to purchase properties.
For example, let’s assume there are two REITs in the market now: ABC and DEF. REIT ABC has a 45% gearing ratio and thus cannot take on more debt unless it increases its asset base. Therefore, if the REIT’s manager wants to expand its property portfolio, new units will need to be issued to raise funds to prop up the asset base. Existing unitholders of REIT ABC may be diluted in the process.
REIT DEF on the other hand, has a 20% gearing ratio. It thus has leeway to take on more debt to fund the purchase of properties and grow its property portfolio without having to issue new units and potentially diluting the interests of its current investors.
Less susceptible to interest rate fluctuations
The second reason why having a low gearing is important is that REITs that have higher leverage will also face higher interest expenses when interest rates rise.
Although most REITs in Singapore are well placed to manage any interest rate hikes, a rate hike can still eat into a REIT’s bottom-line.
It is therefore important to look at the interest rate hedges that a REIT has in place to defer some of the risks of interest rate fluctuations.
The Foolish bottom line
Investing in REITs has become more popular as more Singaporeans learn about the high dividend yields they offer. But, as investors, we should take note of what can make a REIT stand out from its peers. A good place to start would be the gearing ratio; a low ratio allows a REIT to grow its portfolio with greater ease in the future, increasing its dividend yield in the process.