REIT's face higher leverage on unit buybacks: Moody's

Moody's Investors Service says that debt-funded unit buybacks by four rated Australian real estate investment trusts (AREITs) will weaken the companies' credit metrics, but that their good operating performance will also partially allay such concerns.

The buybacks, all things being equal, will weaken the AREITs' leverage -- expressed as net debt/EBITDA -- in the next 12-18 months, although the actual impact will depend on the amounts undertaken. Unit buybacks are an attractive capital management option for the rated A-REITs, which have low gearing, broadly defined as debt/assets, and their unit prices have traded below net tangible assets. Both reasons support the decision to buy back units rather than pursue acquisitions or redevelopments.

Key points are as follows –

 

» Four rated A-REITs have been buying back units. Scentre Group (A2 stable), Dexus (A3 stable), Mirvac Group (A3 stable) and Charter Hall Retail REIT (Baa1 negative) have initiated buybacks worth up to AUD1.6 billion in total. The unit buybacks are likely to be funded by debt because Australian REITs (A-REITs) pay out most of their earnings as distributions to unit holders. Debt-funded buybacks, all things being equal, will weaken

the A-REITs’ net debt/EBITDA financial leverage in the next 12-18 months. Unlike property purchases or investment in redevelopments, unit buybacks will not increase EBITDA. As a result, net debt/EBITDA will increase, depending on the amount of units repurchased.

» Unit buybacks are an attractive capital management option for A-REITs. Most rated A-REITs have low gearing, broadly defined as debt/assets, and their unit prices have traded below net tangible assets. Both reasons support the decision to buy back units rather than pursue acquisitions or redevelopments. Most rated A-REITs’ low gearing reflects a conservative approach to debt, and low cap rates that have increased portfolio

asset values. Also, in many instances, sales of properties have exceeded purchases in Australian dollar terms.

 

» Dexus' and Mirvac's metrics will stay within rating thresholds if debt-funded unit buybacks are implemented in full. Purely as a sensitivity analysis, we have assumed the buyback plans had been implemented in full as at December 2017. In this extreme scenario, Dexus and Mirvac would be able to accommodate fully debt-funded unit buybacks within their existing rating thresholds. Charter Hall Retail would not be able to do so, while Scentre would be at the threshold.

 

» A-REITs' good operating performance partially allays concerns around weaker credit metrics. We expect solid operating income growth will continue for the rated A-REITs. A-REITs will benefit from annual structured rent increases, which underpin our expectation for comparable net income growth of close to 3% for the sector over the next 12-18 months. High occupancy rates and contracted rental income will support both

the office and retail sectors, while the industrial sector will benefit from strong economic activity and limited space availability, especially in Sydney.