Yesterday, I polled the investors if they are willing to give up their dividends to help the tenants.
The results showed that 26% of them (out of 403 voters) were unwilling while the majority 74% were merciful. 32% of them were willing to give up to 29% of the dividends.
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As for the length of time, most of them were willing to sacrifice the dividends over a period of 3 to 6 months.
But it might not be a choice for investors. The pressure has came down from the top – the government. Landlords were reminded again and again to fully pass on the property tax rebates to the tenants.
Mapletree and Capitaland REITs are backed by Temasek and since they are linked to the government, they have to lead by example. In fact, Mapletree Commercial Trust and Capitaland Mall Trust have announced a tenant relief package of S$29m and S$10m respectively, on top of passing the full property tax rebates.
The dividend cut is happening and investors have to be mentally and financially prepared to receive more bad news down the road.
I believe the retail REITs will bear the brunt as footfall has declined significantly and opening hours reduced due to the measures in place. Hospitality Trusts have already taken the hit but are heavily subsidised and supported by the government. Industrial REITs have yet to feel the heat, not until demand comes down in the longer term to affect the production and logistic businesses.
A temporary bill will be tabled to Parliament next week regarding contractual obligations. In short, tenants affected by Covid-19 can delay and accumulate their rental payments over 6 months. This would pose cash flow issues to REITs and limit their ability to pay out dividends. Even if they have recognised the property income, they may not have the cash to pay out.
This was probably the reason SPH REIT cut the dividend by 77% compared to the previous quarter. As for whether they can fulfil the 90% payout requirement to enjoy tax incentives, the assessment is based on the full year rather than just one quarter. If the REIT accumulates losses in future quarters, they might be able to meet the 90% subsequently as the distributable income comes down.
The question is how much can we expect dividends to be cut for the retail REITs?
DBS Research expects retail REITs to cut dividends by a range of 14% to 27%. The reduction comes about with lower Distribution Per Unit (DPU) and Payout ratios.
These are pretty inline with investors expectations from the polls we saw earlier. If so, it should be palatable to most of them if these estimates hold true.
But let’s paint the worst scenario. Assuming ALL the retail REITs tenants’ rent get deferred for 6 months and only half of them are able to pay all their outstanding rent eventually. This would mean the REITs would lose a quarter, or 25%, of gross revenue. Expenses would stay the same and we can assume expenses are 40% of the gross revenue. We also assume the payout ratio to reduce to around 90%.
Here’s the back-of-the-envelope calculation:
The impact would be a 48% drop in dividends!
And let’s stretch the scenario to the worst and see what consequences may turn up.
Assuming the cash flow has reduced so much that they couldn’t fulfil the 90% payout ratio, could the REITs lose their tax incentives?
This is unlikely in my opinion. This is because DPU can also be paid in units if cash is a problem. Also, the rules can be relaxed given the situation. Since the government is willing to extend property tax rebates, it is likely that the payout requirement can be waved as well and tax incentive for REITs remains.
Expect Property Valuation to Decline
Another problem is that the property valuation is likely to come down. But down by how much is an unknown. As REITs are required to maintain below a gearing ratio of 45%, a substantial decline in property valuation would risk increasing this ratio beyond the limit.
MAS did mull about this in 2019 when they published a consultation paper on the possibility of raising the gearing threshold up to 55%, contingent with excellent interest coverage ratio.
So I think this trigger will be pulled if necessary.
In short, the worst scenario for REITs would look something like this:
Rules are set by humans and can be altered if they do not make sense anymore, especially in extreme situations like Covid-19. So I believe the rules for REITs will be relaxed if needed, albeit temporarily.
I definitely hope the drop in property valuation isn’t that drastic because it will set off a contagion to the entire property market. A stock market crash is not going to affect a Singaporean’s net worth by much since only about 8% of their assets are in listed shares and funds. A major hit to the property market will have a significant impact to their net worth considering 42% of the assets are in housing. Something I don’t wish for in our country.
We are starting to see the domino effects due to Covid-19. The number of global cases has just crossed a million and the U.S. hopes to keep deaths below 100,000. We really don’t know how worse can it go and for how long.
We can only prepare for the worst and hope for the best.
