EC World REIT (SGX: BWCU) is in hot water. The Singapore-listed real estate investment trust, which owns properties in China, is having trouble keeping sufficient funds in its interest reserves and the manager of the REIT also claims that the REIT is owed around S$27.5 million (RMB 145.8 million) from one of its tenants.
Its liquidity troubles led the REIT manager to call for a voluntary trading halt of its units. With financial issues mounting, the situation looks rather bleak for unit holders who are now left with no way to offload the units.
While unpleasant, a bad situation presents us with a learning opportunity. With that said, here are some lessons we can takeaway from EC World REIT’s troubles.
Beware of tenant concentration risk
Tenant concentration risk is a big risk for REITs.
EC World REIT is not the only REIT to suffer from missed payments by a major tenant. First REIT (SGX: AW9U), which owns healthcare properties in Indonesia, also suffered a shock a few years ago when its main tenant forced a restructuring of its master lease arrangement, leading to a drastic fall in income for the REIT.
Ability to refinance its debt
EC World REIT first ran into problems when it was unable to refinance its debt that was coming due.
REITs typically take “interest-only” loans. Unlike a home mortgage, in which the borrower pays a fixed amount every month to pay off the interest and a part of the principal, an interest-only loan is a loan where the borrower only pays interest on the loan and does not need to pay back the principal until the loan matures.
As a REIT is required to distribute 90% of its distributable income to its unitholders, a REIT usually does not have enough cash to pay back the principal when a loan matures. As such, the default option is to refinance the loan with a new loan. However, in a situation where the REIT is unable to refinance the loan, the REIT may end up with a liquidity issue.
REITs with stable assets, a diversified tenant base, other means to capital, and low debt-to-asset ratios will likely have less trouble refinancing their debt when it comes due as lenders will be willing to underwrite loans to these REITs. On the other hand, REITs that have unstable assets, tenant concentration risk, or an inability to raise other forms of capital may be at risk of being unable to refinance their debt.
Diversify your investments
A few years ago, I personally invested in both EC World REIT and First REIT (I sold both these companies in 2020). I was willing to invest in them as both offered high yields which I believed was fair compensation for the risks involved.
While there was a chance that the investments could turn sour, I was at least collecting 8-9% in annual distribution yields. Just a few good years and my distributions collected would have paid off my investment principal.
But I also made sure that these investments only made up a small percentage of my entire portfolio. If they turned out well, I would have made a decent return. But if they soured, the impact on my entire portfolio would still be minimal.
Bottom line
Investing is ultimately a game of probabilities. Some companies may provide better yields but have a higher element of risk while others provide lower yields but are less risky.
REIT investing is no different. Although investors tend to think of REITs as safer investments than companies, REITs also have their fair share of risk. REITs typical take on a lot of debt and this high leverage is one of the biggest risk factors for REITs.
In times of rising interest rates and tighter capital markets such as the current environment, the situation becomes even more uncertain for REITs. As such, we need to assess each individual REIT before investing and make sure that we diversify our investments to minimise the risk of ruin.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I do not have a vested interest in any companies mentioned. Holdings are subject to change at any time.