Why more regulatory flexibility crucial for Singapore’s REIT market

The MAS’s proposed regulatory changes are positive, and more can be done to help Singapore REITs thrive in a global economy.

In brief

• The current minimum interest coverage ratio requirement of 2.5 times for REITs may not be realistic in today’s environment of elevated interest rates. 

• The requirement for Singapore REITs to keep their aggregate leverage at 50% or less impedes their ability to compete effectively against global competitors. 

• A flexible regulatory framework can better enhance the resilience of Singapore’s REIT industry, compared with a one-size-fits-all regulatory leverage limit.

In July 2024, the Monetary Authority of Singapore (MAS) issued a consultation paper on proposed amendments to the leverage requirements for real estate investment trusts (REITs). Currently, an REIT is required to have an interest coverage ratio (ICR) of at least 2.5 times if it intends to increase its aggregate leverage from 45% to 50%. Under the consultation, MAS proposes to simplify the leverage requirements by subjecting all REITs to a minimum ICR threshold of 1.5 times and an aggregate leverage limit of 50%. 

REIT players are expected to view this proposal as “sweet rain after a long drought” — a long-awaited, welcome move.

A reality check on the current ICR threshold 

The ICR measures an REIT’s ability to meet its interest payment obligations, i.e., how easily it can pay interest on its outstanding debt. A minimum ICR of 2.5 times to increase the aggregate leverage to 50% means that for every dollar of interest servicing the obligation, an REIT needs to demonstrate it is generating at least 2.5 dollars in earnings to pay its interest expenses. 

This means that for commercial properties with an annual rental yield of between 3% and 5%, the interest rate cannot be more than 2.4% per annum. This is clearly a far cry from the reality of today’s environment where interest rates have remained elevated. In comparison, the proposed minimum ICR threshold of 1.5 times will allow the interest rate limit to increase to 4% per annum, which is much more realistic and reflective of current interest rates.

Greater flexibility to stay competitive

In two decades, Singapore has risen to become the largest REIT market in Asia (excluding Japan) and the country is set to become a global REIT hub. Therefore, Singapore REITs also face competition with global peers in their overseas expansion.

According to the REIT Association of Singapore, over 90% of Singapore REITs and property trusts (by number and market capitalization) own properties outside Singapore across the Asia-Pacific region, South Asia, Europe and the US.¹

It is a balancing act in meeting the objective of ensuring REITs remain as relatively low-risk income-generating vehicles while giving them greater flexibility to cope with changing economic conditions and enhance their competitiveness vis-à-vis foreign REITs. No ICR and leverage limits are currently imposed in more mature REIT jurisdictions, such as Japan, Australia and the US. Therefore, Singapore REITs not only compete with REITs in foreign jurisdictions but also with other global real estate investors and companies, which are also not subject to regulatory leverage limits.

While financial institutions may be willing to lend up to 60% to 75% of the property value to foreign REITs and investors, Singapore REITs have to keep their aggregate leverage at 50% or less at all times due to their regulatory obligation. This impedes their ability to borrow and make the necessary investments to grow and compete effectively against global competitors.

This raises the question of whether a one-size-fits-all regulatory leverage limit is optimal. Financial institutions, being in the business of lending and risk assessment, often have more sophisticated and up-to-date information about the borrower’s financial health and risk profile. They also conduct rigorous due diligence and risk assessments before extending loans. Therefore, taking a cue from financial institutions could be useful. Given their diverse risk appetites, financial institutions are well-positioned to determine appropriate loan-to-asset ratios rather than being subject to a hard 50% limit.

In more mature REIT regimes, investors make investment decisions on REITs based on their assessment of the REIT’s financial stability (including capital structure) and are not guided by regulatory limits. Such an approach allows for more dynamic and competitive market behavior and may be considered for Singapore REITs when the time is right.