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Monday, March 02, 2015

REITs - Key Indicators that Affect Your Investment Choices

In my previous article, I wrote about the virtues of REITs (REITs, pronounced "Reets"). Whilst it's easy to paint a good picture, it is equally important to highlight some aspects and metrics that would have an impact on our REIT investment choices. 


Credit Image: Shutterstock

Valuation


NAV - Net asset value, is the value of an entity's assets minus the value of its liabilities. Simply put, this is calculated by taking all of the current assets of the REIT, minus away its liabilities, divided by its units outstanding in the stock market. The result is an estimate of the intrinsic value of the REIT, which serves as a yardstick for assessment.  

A REIT with a high NAV with respect to its share price, is said to under valued by the market. Conversely, a REIT with a low NAV with respect to its share price is said to be over valued (or highly favored). In theory, the quoted share price should usually does not stray too far from the NAV per share.


Interest Rates


Interest Rates have a direct correlation on the price and financial health of a REIT. This is because in general, properties bought in trust by the REITs are usually heavily leveraged (up to 35%* based on MAS regulations). To simplify it further, this means that for every $100 worth of property, a maximum of $35 used to buy it can be borrowed from a bank or financial institution. 

This 35% would incur a borrowing costs (See "Gearing") and it is dependent on the movement in interest rates. In an environment where interest rates are low, interest expense will be manageable, thereby positively affecting a REIT's profitability. On the flip side, when interest rates are high, there will be a negative impact on the bottom line of the REIT. 


To fully understand the impact of interest rate movements, it is important to weigh the proportion of fixed versus floating-rate debt. In a low interest rate environment, a REIT that uses only floating-rate debt will be hurt if interest rates rise.

* At present, REITs are subject to a leverage limit of 35% of their total assets. This limit can be increased to 60% if the REIT obtains a credit rating and discloses the rating to the public.



Gearing


Most, if not all, REITs require heavy financing for their property acquisitions and operations. The gearing ratio is an indicator of the financial leverage undertaken by the REIT. It is the total borrowings (both short-term and long-term) divided by total assets. 

REITs with high gearing tend to be more risky, especially when borrowing becomes expensive (when interest rates goes up). In general, most S-REITs (Singapore REITS) have acceptable levels of debt. However, it is worth while to note that higher gearing means higher borrowing costs and potentially translates to lesser net profits. This in turn affects the distributions that are paid out to its unit holders.


Occupancy


The main driver of revenues from REITs are the rental income from leasing. In an ideal world, trustees would hope to achieve 100% occupancy of the properties under their management. However, tenancy rates are dependent heavily on several factors. Tenants have to consider rental costs, geographical location, competitiveness and lease tenures among others.

When considering a REIT, it is important to look at its occupancy rates. It gives a good indication of the management strategy, prospects for growth and future rental income collection. 


Distributions


Distributions are the main drivers of investors to REITs. While similar to dividends, companies that give dividends usually have no obligation or fixed policy to do so but distributions are a necessity for REITs.


Distribution yield is calculated by taking the total annual DPU (distribution per unit) divided by the price of the stock at the point in time the yield is to be calculated, multiply by 100%. 

Example: 


$0.065 (total annual DPU) / $1.040 (price of stock when calculating yield) x 100% = 6.25%


What this means is that, based on the price of $1.04, the REIT returns 6.25% annually. For simple illustration purposes, with every $10,000 invested in the REIT, you can expect $625 of returns annually! 


Assuming that the current stock price is now at $1.25 instead of $1.04 and assuming that the total annual distribution stays the same at $0.065 per annum, the current distribution yield is no longer 6.25% but 5.20%. Its yield has dropped by more than 1%, making it significantly less attractive to buy at the price of $1.25. As a potential investor, you would want to use the correlation of the price and yield to decide if a REIT is worthwhile as an investment.

Distributions of REITs are typically paid out semi-annually or quarterly. This website does an amazing job of listing the REITs and the frequency of their distributions. It is a great resource when you need access to clear and summarized information.

Summary


I would advocate having a balanced portfolio and doing the due diligence when investing your hard earned money. Although not 100% risk free, using the above points as a reference when selecting a REIT to invest, will ensure that you are in good stead. Hope you find this short article useful and good luck to your journey to financial freedom! :)


My Personal REIT Holdings:


Mapletree Greater China Trust  (SGX: RW0U)

CounterCodeSharesAvg. PriceCurrent PriceCurrent YieldDistribution ('14)Freq.
MGCTRW0U170000.91501.04006.34%$0.06282 Semi-Annual