July 27, 2013
When computing how much debt a company is taking on as compared to its equity, the debt equity ratio is usually used. Debt equity ratio is the total mortgage taken by the company divided by the equity price of the company at the point where the ratio is calculated. These computations are useful for the REIT although the usual REIT measurement is the gearing ratio. The ratio is also known as Debt-to-Asset Ratio
Gearing – A fundamental analysis ratio of a company’s level of long-term debt compared to its equity capital.
In computing for the gearing ratio of REIT, the amount borrowed to acquire its properties is divided by the total assets of the REIT. There are incentives for Singapore REITs to keep their gearing ratio low at not more than 35%. Complying REITs that have gearing ratio of less than 35% are allowed to enjoy preferential tax treatments. This legislative provision also stipulates this to protect the REIT from unexpected contingencies and economic turmoil.
Since REITs in Singapore are required to distribute 90% or more of its taxable profits thus when some unexpected contingencies or during economic turmoil, the REIT would not be at the mercy of banks when they are refinancing their properties.
There is an exception though. A REIT is able to push their gearing ratio up to 60% if the REIT is rated by stipulated rating agencies like Moody’s, Standards & Poor’s (S&P) and Fitch Group. The rating grade must be at least investment grade (Baa3 for Moody’s and BBB- for both S&P and Fitch).
With the Distribution Yield the investor is able to anticipate the returns from the REIT, while knowing the gearing ratio, the investor is given an idea of how risky the REIT is.
How to Compute Gearing Ratio
Gearing ratio is calculated by taking the gross borrowings divided by the total assets based on the latest valuation of the REIT. Here we will use Suntec REIT and Starhill Global REIT as an example in our computation.
A quick look at Suntec REIT’s and Starhill Global REIT’s property valuation as of 31st December 2012 and financial result of 2Q 2013:
|Property Valuation||Financial Result|
|Starhill Global REIT||View||View|
The gearing ratio of Suntec REIT and Starhill Global REIT can computed as follows:
|Suntec REIT||Starhill Global REIT|
|Total Gross Borrowings||S$2,905,000,000||S$855,370,000|
|Total Assets Valuation||S$7,837,000,000||S$2,713,000,000*|
*Starhill Global REIT’s property valuation does not include its latest acquired property Plaza Arcade in Perth, Australia.
REITs without a credit rating from a recognized rating agency are not allowed to exceed their gearing ratio of 35%. This is clearly stated under the Property Fund Guidelines of the CIS code. However, in rare instances, a REIT is able to exceed this limit. This is due to the depreciated value of the total asset of the REIT. Under this circumstance, the REIT is not required to obtain a credit rating, but must cease any further borrowing.
Do take a look at the REIT’s historical gearing ratio when sourcing for an opportunity to increase your portfolio of REITs. A consistently high gearing ratio or annual increase in the gearing ratio may not be a good thing.