What is gearing?
In the most simple terms, gearing is calculated by the amount of liabilities dividends by the total assets valuation.
Let's say for REIT X, the valuation of all its buildings and assets comes out to $1 billion. The total liabilities is $300 million. This will work out to a gearing of 30%. [I stand to be corrected in my concepts. Feel free to comment if my understanding is wrong.]
Different countries would have different policies for the maximum gearing for a REIT. In Singapore, there's a cap of 35% gearing.
Indeed, as I have pointed before, gearing is a factor in my consideration on whether to put my monies with a REIT. But we have to take note that gearing is not the sole criteria.
Why some gearing is important for a REIT
To me, REITs are leveraged instruments. Why leveraged instruments? It's because they leverage on debts to grow. By buying into a REIT, we are also buying into the leverage. Just like if we are buying a property on bank loan, we would be using leverage too. The main difference is that the debts of a REIT are non-recourse to us. If the REIT goes bankrupt, only our principal is gone; we do need to repay the debts. We can't do that we properties we own.
We can't expect a REIT to function with zero gearing or too low a gearing. This is because usually, the returns of a REIT surpass the interest paid on the debts. There's no point leaving the cash in the bank when you can earn much more by borrowing the money to multiply it faster than bank interest; i.e. leveraging on debt.
This, is how financial instituitions earn from giving fixed deposits (i.e. Sing Investments). This, is also how businesses and REITs earn. Debt is a double edge sword which has to be manipulated carefully for the greatest benefit to us.
Without any gearing, the rate of growth, the amount of earnings that a REIT earns could possibly be reduced as compared to another similar REIT with perhaps 30% gearing.
Debts are sometimes viewed negatively. But prudent debts taken to earn should be viewed with a more positive note. However, the distinction between prudent and non-prudent is something very subjective. Then again, everything we think and do usually has an element of subjectivity.
Newly added (thanks to cw8888!):
That said, we still have to bear in mind that gearing to a REIT is not as important as it's ability to secure refinancing of its debts. However, a lower gearing is usually desired for a REIT as it can usually help the REIT secure financing or refinancing easier.
How REITs can increase or decrease gearing
This is where mathematics come into play. Simply put, REITs can easily decrease their gearing by having a rise in the valuations of the buildings they own, and vice versa. When a REIT's gearing is high in times of recession where property prices are depressed, we can be sure that when the economy picks up in the future with increasing property prices, the gearing will decrease, and the REIT will be able to borrow more to finance new purchases. Of course, this is a double edged sword as it would also mean REITs would be purchasing more expensive assets.
This basically sums up my thoughts on the gearing of REITs. I will update this post when I have new insights or ideas on gearings.