The REITs universe here is getting bigger and is set to expand further in terms of size and diversity. Covid-19, however, has caused different REITs to react drastically differently in the event of financial difficulty. This has inspired the Singapore Exchange Regulation (SGX RegCo) to float tweaks to the listing rules applicable to this sector.
For example, data centre and logistics REITs may remain unscathed or even enjoyed a huge surge in interest. But it is a totally different story for hospitality REITs. In perhaps the most notorious case, Eagle Hospitality Trust — which owns a portfolio of US hotels — went under dramatically just a year after its listing. The pandemic has been cited as a catalyst for its loan defaults but authorities have also tackled the parties involved with a long litany of possible breaches that is now under investigation.
EHT, which has multiple master leases to basically the same entity — which is also its sponsor, Urban Commons — suffers from what can be described as a concentration risk. The term refers to the potential loss of an investment portfolio’s value when an individual or group of securities moves in an adverse direction.
One possible solution to this is to cap the numbers of hotel properties that can be leased to the sponsor. “Let me be the first to admit there are certain drawbacks to this suggestion. It could, for example, prejudice a big sponsor versus a smaller one and therefore mean potential REIT listings of a certain size may shun our market. I’m sure you agree with me that that would be unfortunate,” says SGX RegCo’s CEO Tan Boon Gin on Nov 19.
Another suggestion is to tighten the criteria for master lessees by making sure the master lessees have enough financial muscle to fulfil their obligations. “Some might say that this could be by way of a credit rating. But even those ratings have in the past proven not to be foolproof. So, we would be inclined to consider other measurable means to ascertain the financial worthiness of the lessees,” notes Tan.
Without making direct reference to EHT, Tan acknowledges that within the hospitality REIT sector it is common for the sponsor to be the master lessee of all the hotel properties in the REIT portfolio. “There are certain advantages to this arrangement, including the smoothing out of lumpy income streams throughout the year by swapping variable rents for a fixed rent payable to the REIT. However, as recent events have shown, it also introduces a high degree of concentration risk,” he adds.
Tan was speaking at a webinar organised by the REIT Association of Singapore on the topic of “What do you need to know as an independent director of a REIT manager”. At the virtual event held on Nov 19, he stresses that these are just suggestions for now and no decision has been made if any — if at all — should be implemented.
Tan, citing the exchange’s long-held approach of a disclosure-based regime, is also mulling if having comprehensive disclosures might be one way to address the risk. “For example, we may require the master lessees to provide comprehensive disclosures on their financials in the prospectus at IPO,” he says.
He agrees that concentration risk is not a new risk, which is now being dealt with by requiring a higher security deposit. In the event of a master lessee default, the REIT can still fulfill its financial obligations, such as distributions to its unitholders as the search for a new master lessee goes on.
“But recent events have shown that enforcement of security deposits can run into complications if the REIT’s assets are overseas, as the lending practices and conventions over there may differ from those that we are used to locally,” says Tan, again without making reference to EHT. But this was what happened exactly in the latter’s case.
One way to buttress the enforceability of these security deposits is to better ring-fence the security deposits. For example, the exchange may require deposits to be held by financial institutions independent of the REIT and its creditors.
Also, the exchange can require additional legal due diligence on the lease documents and lending agreements. This will ensure that the REIT is able to freely draw on the security deposits when it needs them the most. Finally, the exchange can also require a legal opinion confirming the enforceability of the security deposits to be disclosed in the prospectus.