Occupier insolvency risks to landlords

The COVID-19 outbreak has given landlords an unprecedented situation with the global economy coming to a virtual standstill and much of the world’s office population working remotely. As markets start to tilt in favour of occupiers, the economic toll on corporate earnings remains uncertain and landlords need to be mindful of the potential downside risk to their occupancies as the likelihood of insolvencies rise the longer this outbreak lasts. To better understand this, we briefly analysed the state of public corporate balance sheets across four major office markets within the Asia-Pacific region – Singapore, Hong Kong, Tokyo and Australia, via their leverage and liquidity metrics and how they have trended since the Global Financial Crisis (GFC).

Has leverage improved? 

We start by looking at leverage across these four major markets by analysing the overall debt to equity ratios of all the publicly listed companies on their respective domestic stock indices.

• Singapore -> Straits Times Index (STI)

• Hong Kong -> Hang Seng Index (HSI)

• Tokyo -> Tokyo Stock Price Index (TOPIX)

• Australia -> S&P’s Australia Securities Exchange 200 (ASX200)

And we found that all the markets have seen their corporate leverage rates decline since the GFC; some much better than others. The charts below show the various debt to equity ratios (the lower the better) for each market.

     

     

Hong Kong recorded the biggest change with its leverage declining 30% post the GFC, while the other markets saw deleveraging of between 15 to 20%. Currently, Singapore’s corporates are the least leveraged with a debt to equity ratio of 69%, driven in part by the growing market share of its public real estate investment trusts (REITs) which have to abide by a mandatory 45% leverage limit.

On the other hand, Australia has the highest leverage at 170%, led mainly by its financial sector which accounts for about a quarter of its stock index’s market share. However, while its corporate leverage rate is high compare to the other markets, it must be noted that the corporate leverage rate has been relatively stable following a de-rating from its GFC highs.

Will liquidity be a concern in the near term?

Next, we looked at liquidity risks across the markets by analysing their current ratios. This liquidity metric measures a company’s ability to pay short term liabilities that are generally due within one year and allows one to better understand how a company can maximize the current assets on its balance sheet to meet its current liabilities.

What we found was apart from Australia, the other markets have seen their current ratios deteriorate since the GFC. The charts below show the various current ratios (the higher the better) for each market.

     

     

Australia stood out among the four markets with its current ratio rising slightly to 1.17 times compared to the 1.15 times recorded in 2008, while Tokyo was not far behind with its 1.25 times ratio compared to its 2008’s 1.24. Singapore saw the worse deterioration among the four with its corporate current ratio falling from 1.41 times in 2008 to 1.21 times in 2019. Overall, corporates across the four markets have enough liquid current assets (e.g. cash and cash equivalents, short term receivables, marketable securities) to cover their current liabilities by between 1.2 to 1.3 times.

What does this all mean?

While we have yet to fully grasp the economic impact of COVID-19, landlords need to be cognisant of tenancy risks within their assets as their tenants face unprecedented pressure to their bottom lines. Looking across the major Asia-Pacific markets, leverage has decreased generally over the years but there are potential risks in Australia with its relatively higher leveraged financial firms.

Next, there are no immediate cashflow concerns as current ratios between 1.2 to 1.3 times suggests that corporates have sufficient short-term liquidity to cover their near-term liabilities, plus some buffer. However, as revenues shrink and expenses expected to remain the same, corporate cash reserves will be tapped into as losses mount thereby increasing liquidity risks. Even low leveraged markets could face difficulties raising debt to cover near term cashflow needs as banks will grow more cautious on their credit lines. As such, landlords will need to work with their tenants closely to manage their cash flows so as to reduce any leasing risks to their assets; quality tenant retention should be a landlord’s highest priority at this juncture.