The place for debt in A-REITs

Debt is an essential component of A-REIT balance sheets. An A-REIT can increase its returns by employing debt secured against the value of its underlying real estate, a technique known as leverage or gearing. The effective management of debt is an essential skill in the effective management of an A-REIT.

Until the onset of the GFC, the use of gearing was stimulated by the relatively low cost and availability of debt capital, which enabled an increase in A-REIT earnings by acquiring positively geared property. However, excessive levels of gearing magnified the steep decline in asset values during the GFC.

In 2006, the A-REIT sector, as represented by the S&P/ASX 300 A-REIT Index, was geared to 37%. This figure is now a more conservative 30%, lowered by a combination of asset sales and recapitalisation of balance sheets through the raising of new equity capital. The interest coverage ratio, or the ratio of income to interest payable on debt, has increased from 3.1 times in 2006 to a relatively healthy 3.9 times today, in line with the lower level of debt employed in the sector.

A-REITs tend to split their debt between fixed-rate and floating-rate facilities. The current average is 69% fixed, giving some degree of interest rate certainty. Much of this debt comes from the banking sector which holds about 50% of all A-REIT debt, public markets holding a further 40% and private lenders which holds the balance.

A-REITs range widely in their use of gearing. Goodman Group employs a gearing level of 36% while Westfield Group also carries relatively high gearing of 40%. Both these groups incorporate significant development operations. Others, such as GPT and Westfield Retail Trust, carry more conservative gearing of just 23% and 21% respectively.

Gearing must be appropriately structured and managed, and set in a portfolio that can sustain it. The consequences of excessive gearing can be disastrous, as demonstrated by A-REITs such as Centro, which crashed after being unable to refinance the debt it had amassed to fund acquisitions.