Here's what could be Singapore REITs' buffer against supply, interest risks

Operations expected to be stable.

According to Fitch Ratings, Singapore-listed real estate investment trusts (REITs) are highly leveraged in a low-interest environment, and face a looming risk of rising supply in some sub-markets.

Nonetheless, ratings pressures are buffered - for now - by Fitch's expectation of stable operating performance, the backing of strong sponsors especially at the larger REITs, and the continuing strength of the regulatory environment.

Here's more from Fitch:

A key risk is high FFO-adjusted net leverage, and ongoing exposure to refinancing risk in the (unlikely) event of loans not being renewed or if asset values plummet more than expected. Our latest un-weighted average estimates this at 6.64x across all three sub-markets - hospitality, industrials and healthcare.

The high leverage is not a surprise, as several years of low real interest rates have raised asset values and also pushed up borrowing.

Expansionary capex has exacerbated this in the hospitality sub-market. In a rising interest-rate environment, however, the REITS may be able to switch to secured borrowings or securitisation - given that the assets of the established REITs are mostly unencumbered.

Another risk is that of a potential drop in rental income amid the imminent rise in property supply. This is particularly salient for the hospitality industry, which is the most cyclical and leveraged of the REITs under Fitch's coverage.

It is also important for industrial REITs which are likely to see a significant ramp-up in multi-user factory space by 2015. Declining rental income and lower asset valuations would almost certainly worsen the sector's financial metrics.

Nonetheless, we see credit pressures as evenly balanced; and all four of Fitch-rated REITs carry a stable outlook - out of the 13 listed companies in the healthcare, industrial and hospitality sectors. This is for three crucial reasons.

First, operating metrics should remain generally stable. The outlook for healthcare is underpinned by an ageing population, medical tourism and lease agreements with a triple net clause that insulates the REITs from increases in operating expenses, property insurance and tax.

Industrial REITs benefit somewhat from low vacancy rates, stable lease expiry tenors of around three years, competitive rental structures, and a high proportion of single-tenanted properties.

Meanwhile, certain hospitality REITs also benefit from geographical diversification, multiple asset categories (ranging from hotels to serviced residences), lease agreements that include a triple net lease clause, and a rise in tourist arrivals.

But hospitality is more exposed to the risk of a supply overhang, not being matched by continuing or commensurate tourism inflows.

Second, larger REITs in the sector are backed by strong sponsors. Backers include both well-established private- as well as public-sector holding companies with a track record of injecting stable and performing properties, and access to diversified and competitive funding sources.

Third, the regulatory environment remains robust, and limits undue risk-taking across the sector. Loan-to-value ratios are limited by the Monetary Authority of Singapore (MAS) to 60% for rated entities, and a more stringent 35% for unrated entities.

Moreover, the MAS also requires REITs to invest at least 90% of their assets in income-producing assets.

The upshot is that high leverage and an anticipated boost in supply will not inevitably result in unsustainable credit pressure across Singaporean REITs.

This is because stable operating metrics, strong sponsor backing and a robust regulatory environment are important countervailing sources of credit support.