Since the inception of REIT-it, many readers have asked about the key factors to consider when we look at which Real Estate Investment Trust (REIT) to invest in. In this post, REIT-it shall attempt to summarize key considerations when investing in a REIT into 5 points:
1) Distribution Per Unit (DPU) History
A quick mental shortcut would be to look at history of DPU of a REIT but this does not work for REIT that are new. Please see below for more comprehensive factors to assess a REIT performance.
While history cannot tell the future, DPU history does provide some insights into the performance and ability of the management to make sound decisions for the REIT. As a shareholder of REITs, we ultimately do not have control over the acquisitions made by the REIT manager. REITs run on track record and DPU history, in my opinion, is the best proxy to gauge this ability. Should the history be long enough, we would be able to observe the REIT manager’s ability to navigate the storm during recession.
This data can usually be obtained from the website of various REITs:
Source: Mapletree Industrial Trust
For example, looking at Mapletree Industrial Trust’s DPU history, one would see that there is constant growth on the per unit distribution and hence represent strong ability of the management to create value for shareholders. This set of data certainly help instill some confidence but one has to look at the recent acquisition of US data centres and decide if such an additional would be a plus to the existing business.
Source: Ascendas REIT
Ascendas REIT seems to have been affected by the financial crisis in 2008/09 but has been able to recover from the financial crisis ever since. The 14% drop in DPU is minor, compared to the loss in value Strait Times Index experienced during the same period, which was a drop of over 60%.
We should keep in mind that this information gives us an indication of how a REIT has been performing and does not fully represent the future. This information should be used together with other information stated below to get a fuller view of what is to be expected of the REIT.
2) Asset Class
REITs generally falls into the following categories in accordance to their underlying asset portfolio:
- Commercial (Offices): An asset class that combines stability (average lease term of at least 3 years) with potential capital gains considering that some of the Commercial REITs consist of assets occupying prime areas in Singapore. It’s currently “flavour of the day” considering that global economy is seeing some expansion and rental rates have been recovering from lows in recent years.
- Industrial (Business Parks, Warehouses, Factories): Not an asset class that REIT-it favours the most considering short land tenure on Singapore industrial land. REIT-it’s advice is to be selective on this asset class, overweighting REITs with Business Park and Logistics space in good locations.
- Healthcare: REIT-it’s favourite thematic play. Healthcare REIT is the most stable asset class considering that most leases are averaging 10 to 15 years. With an upward trend in healthcare needs, REIT-it believes that Healthcare REITs is highly suitable for long term investment.
- Hospitality (Hotels or Serviced Residence): Not an asset class that REIT-it would be interested in considering that hotels usually consist of short stays, which hence cause the occupancy and derived income to be highly volatile. Such volatile investment is against REIT-it’s philosophy that REITs investment should provide highly stable cash flows.
- Retail (Shopping Malls): An old favourite amongst investors considering CapitaMall Trust (CMT) was the first REIT in Singapore. E-Commerce has posed major problems to the profitability of shopping malls and hence investors should only consider Retail REITs with malls situated in key locations (especially those beside MRT stations with high footfall on account of the value of the underlying land).
3) Asset Performance
Occupancy Rate (%)
Occupancy refers to how much of the space available in the assets (commonly known as Net Lettable Area/NLA) are leased – which most of the time means that these spaces are generating some income. A higher occupancy rate is always preferred and reflects on the surface if the asset is desirable to space users. A low occupancy rate may reflect problems on the assets and more investigation should be done when low occupancy rate is encountered.
As occupancy rate is a common indicator observed by investors, some REIT managers may seek to prop up this number by offering very cheap rental or giving long rent-free periods on leases to entice new lease take-ups. As such even when high occupancy is observed, REIT-it would suggest that investors do more in-depth investigations
Rental Rate (S$ psf per month)
Investigation on the quality of building occupancy can be done by comparing effective rental rate (S$ psf per month) achieved by the building across multiple years. This rate can be calculated by dividing rental income against net lettable area (NLA) of the asset. A rising effective rental rate would suggest quality performance that underpins stable performance of the REIT.
Weighted Average Lease Expiry (WALE)
Weighted average lease expiry (WALE) measures how long the current existing leases will continue for before renewal of leases takes place. This indicator is important as it tells us how long the existing cash flow from rental runs till before negotiation for new leases will have to take place. During the renewal/ negotiation phase, existing tenants may decide to shift out of the building and this will then affect the stable cash flow that we desire when investing in a REIT.
Lease expiry is a key risk to our desired cash flow and hence the longer the WALE, the more stable the cash flow of a REIT is.
Something that investors often miss out when assessing the quality of an asset. Concentration ratio refers to how much space in the asset is taken up by the top few largest tenants. Single-tenanted assets are generally not favourable as there is a risk of non-renewal by this tenant which might leave the entire asset empty for a long time. Investors should also be mindful when a single tenant takes up more than 20% of the space in a building.
4) Gearing Ratio/Debt-to-Asset Ratio
S-REITs are regulated by MAS under the Property Fund Guidelines to have no more than 45.0% in debt-to-asset ratio (derived using total debt divided by total asset on balance sheet). By rule of thumb, S-REITs usually keep their gearing ratio below 40.0% to be viewed favourably by investors as a reasonably levered company that does not take on excessive risk.
From an investment perspective, this ratio should be closely watched as a lower gearing ratio necessary means that the REIT can make property acquisitions using debt instead of raising more money from shareholders. Debt-funded acquisitions will help to increase the distribution per unit (DPU) as debt cost is usually cheaper than cost of equity.
As such, do look out for REITs with lower gearing ratio as their current yield may be further boosted by debt-funded acquisitions.
Buying into REITs with high gearing ratio also means that the REIT will have to raise money from investors for the next acquisition. The REIT can either issue Placement Shares or do a Rights Issue.
Placement Shares are allocated to institutional investors and is dilutive to existing retail investors like you and me. As such, avoid REITs that frequently use Placement Shares as a mean to raise additional equity, as shareholders’ value is not maximized by such exercises.
In contrast, Rights Issue gives all existing investors equal opportunity to obtain more shares in the REIT at a discounted price. The key is not about the discounted price but the equal opportunity as the latter ensures that one’s stake in the company does not get diluted and hence has less proportionate claim to the REIT’s distributable income.
There are many haters out there claiming that REITs destroy value by raising more shareholders’ money. The truth is, if one has decided to invest in REITs, there will always be a need to invest more cash as a REIT with growth ambition will always need more cash. So whenever there is a Rights Issue, REIT-it’s advice would be to participate and subscribe for excess.
More will be covered in the future on this concept.
5) Interest Rate/Cost of Borrowings (%)
REITs, as with real estate business in general, is highly capital intensive and is high dependent on debt financing. With a typical debt-to-asset ratio of between 30% and 45%, interest cost is a major expense faced by a REIT. While interest expense does not affect Net Property Income (NPI), this expense is paid before any income is distributed to shareholders like you and me.
As such, beyond the performance of the underlying assets, effective capital management (managing the interest cost and hedging currency risks) is a key marker of the REIT manager’s ability to deliver value to investors.
More on this concept will be discussed in the subsequent post, but for now, what this means is that before we invest in a REIT, we should compare its cost of borrowings against its peers. REIT-it has done a consolidation previously of all the borrowing costs in the previous post found here: https://reitit.org/2018/03/23/increasing-interest-rates-on-s-reits/#more-95
Myth: High Distribution Yield (%)
REIT-it has seen many investment blogs speaking about going for REITs with higher distribution yield. REIT-it would like to remind investors that higher yield usually means that there is higher risk involved in such investment.
For beginners, REIT-it would advise looking at REITs offering 5% to 6%. Such low yields as compared to the S-REIT universe is usually offered by REITs with large sponsors in the like of CapitaLand, Mapletree and Ascendas. These names have strong track record in delivering value to shareholders and would provide a safe start to your investing journey.
As such REIT-it would like to advise against high yield chasing as you might end up going up the risk curve and lose your precious capital when the share price decline drastically.
The key theory that summarizes the five mentioned points is simply: CASH GENERATION.
REITs investment, in my personal opinion, is the purest form of value investing, where all we are concerned with is how much cash can the asset generate each quarter. In order to generate cash for shareholders, a REIT’s key performance indicators would be its ability to maximize revenue and minimize expenses. A REIT that is able to do this well would be the vehicle that we are all looking to invest in.
Hope this post helps you embark on your first REIT investment.
Before we end, REIT-it would like to bring your attention to REITs Symposium 2018 jointly organized by ShareInvestor and REIT Association of Singapore (REITAS).
The good news is REIT-it readers get a special 30% discount off original ticket price (S$14 after discount). REIT-it believes that this is an inexpensive way for budding REIT investors to get exposed to the various REITs available on SGX. Besides presentations by various REITs, there will also be panel sessions that may provide some insights into interesting topics such as interest rate hikes and investment in overseas assets. To sign up,
- Click on this link: https://goo.gl/HanS4d
- Enter promo code: REITIT
That’s all I have for this post. Till we meet again…