REITS has to distribute 90% of their income to the Unitholders. This means that it relies very much on debts for growth. Increase in interest rate will increase the cost of borrowing which eats into the income to be distributed.
2. Losing attractiveness as an alternative investment
In an high interest rate environment, there are safer alternative investments such as buying Treasury bills (Yield was at a 30-year high of 4.4% in December 2022) and placing deposits in bank. Hence, investors likely will turn to these investments that offers a lower risk.
3. Valuation of properties may drop
A high interest rate may lead to an increase in the capitalisation rate. According to the webpage dated 1st Feb 2024 from jpmorgan.com, the Fed’s interest rate hikes increased financing costs, limiting transaction volume and making it difficult to assess capitalisation rates. As a result, capitalisation rates have increased in the United States of America.
The formula to assess the value of property:
Value of property = Net property Income/ Capitalisation rate
When valuation of properties drop, the gearing ratio will increase which cause some of highly leveraged REITs to breach the gearing limit. Thus, financial institutions such as banks will be reluctant to extend loans to such REITS. This may force them to sell off assets at a loss or turn to investors to raise liquidity both of which are detrimental to investors.
Actions I wish I have taken along with Federal Reserve continually raising the interest rate
I wish I have sold some of the REITS at a higher price and perhaps buy it back when it corrected to an attractive pricing. These would have reduce the capital loss on my investments in REITS. However, timing the market is undeniably hard to execute.
Buy and hold has proven to be harmful to the portfolio. The upward trajectory for the interest rates undertaken by Fed has shown that the REITS took quite long to recover to their earlier pricing. A number of REITS has still not fully recovered to their prices in 2022.
limited impact (loan expiry only in 2026 and 2027)
Estimated DPU
0.0282 EUR
DPU impact due to cost of debt increase by 3%
current loan expired only on 2026 or 2027
DPU after interest rate Impact
0.0282 EUR
Estimated Currency impact Jan 2022 vis a vis Oct 2022
1.53 vs 1.4 EUR
Estimated % of Currency Impact
-8.5%
Estimated Overall impact
-8.5%
Resultant Estimated Dividend Yield (In SGD)
7.1%
Negative
Europe currency fluctuation. Ongoing energy crisis in Europe drives up the power bills which result in higher business cost.
Positive
Loan expiry is only in 2026 or 2027.
Disclaimer: I may own the above REIT and this post is not a recommendation to buy or sell. The above calculation is just an estimate (may be flawed or contain errors) and is based on my own hypothetical assumptions on a layman understanding without taking into consideration of factors such as hedging, some other macroeconomic factors and etc. Hence, the actual dividend yield may differ significantly from my calculations.
Estimated Currency impact Jan 2022 vis a vis Oct 2022
1.82 vs 1.59 GBP
Estimated % of Currency Impact
-13%
Estimated Overall impact
-20%
Resultant Estimated Dividend Yield (In SGD)
7.9%
Negative
UK currency fluctuation and significant impact from if cost of debt increases.
Positive
Built in Inflation-linked Rent uplift with a small proportion based on open market value.
Disclaimer: I may own the above REIT and this post is not a recommendation to buy or sell. The above calculation is just an estimate (may be flawed or contain errors) and is based on my own hypothetical assumptions on a layman understanding without taking into consideration of factors such as hedging, some other macroeconomic factors and etc. Hence, the actual dividend yield may differ significantly from my calculations.
Estimated Currency impact Jan 2022 vis a vis Oct 2022
1.53 vs 1.4 Euro (~30% by book value*) 1.82 vs 1.59 GBP (~10% in UK by book value)
Estimated % of Currency Impact
8.5% drop for EUR 12.5% drop for UK
Estimated Overall impact
-7.7%
Resultant Estimated Dividend Yield (In SGD)
5.86%
Negative
Europe and UK currency fluctuation. Ongoing energy crisis in Europe drives up the power bills which result in higher business cost.
Positive
Build-in rental increments ensures stability of income growth. Being conservative, I have not included it in my estimation of resultant yield
Disclaimer: I may own the above REIT and this post is not a recommendation to buy or sell. The above calculation is just an estimate (may be flawed or contain errors) and is based on my own hypothetical assumptions on a layman understanding without taking into consideration of factors such as hedging, some other macroeconomic factors and etc. Hence, the actual dividend yield may differ significantly from my calculations.
*Using book value as I could not find break down of geographical assets based on income.
Estimated Currency impact Jan 2022 vis a vis Oct 2022
1.35 vs 1.43 USD
Estimated % of Currency Impact
6%
Estimated above overall impact
-1%
Resultant Estimated Dividend Yield (In SGD)
9.9%
Negative
Focus on office space will be quality over size. Hence, requirement for office space will decrease due to hybrid work arrangement? Technology sector not doing as as well may continue to consolidate and cut back on office spending i.e Meta Platforms? Current all-in average cost of debt is not low at 2.88%.
Positive
USD remain fairly strong and positive rental reversions of 1.6%.
Disclaimer: I may own the above REIT and this post is not a recommendation to buy or sell. The above calculation is just an estimate (may be flawed or contain errors) and is based on my own hypothetical assumptions on a layman understanding without taking into consideration of factors such as hedging, some other macroeconomic factors and etc. Hence, the actual dividend yield may differ significantly from my calculations.
1. Is there an increasing Distribution Per Unit year on year
As investors, we will want our Distribution Per Unit (DPU) to grow year on year which helps to offset the effect of inflation. A growing DPU also mean that the manager is competent and have their interest align with the unitholders.
A good example will be Frasers Centrepoint Trust (FCT) has managed to grow its DPU from 6.55 to 12.085 cents every year since Financial Year 2007 to 2021 except for FY2020 (when it was affected by COVID-19) as shown in the graph below.
Source: Slide 6 of Frasers Centrepoint Trust 2022 Investor March 2022 Presentation
2. Positive Rental Reversions
Rental Reversion is a metric captured by REITs to show whether new leases signed have higher or lower rental rates than before. It is an useful indicator for investors to assess if a REIT is able to grow its revenue.
REITS with a history of positive rental reversion are welcomed by investors as positive rental reversion in the properties will usually contribute to a rise in DPU. It also assures the investors that the properties are sought after and well managed by the REIT. Vice Versa, a negative rental reversion will lead to a drop in DPU. I will avoid those REITS with negative rental reversions unless due to unusual circumstances like COVID.
However, currently for REITS, there is no consistent way to calculate rental reversions and it is not a mandatory disclosure requirement.
From the latest press release of FCT on 27 Apr 2022, positive rental reversion of 1.73% (See table below) was achieved on an incoming versus outgoing basis for 14.4% of FCT retail portfolio’s total net lettable area in 1H2022. This keeps investors optimistic that the retail sector is on the road to recovery after COVID’s impact. With the easing of restrictions on group size and dining-in, increased in footfall is anticipated.
Source: Slide 19 of of Financial Results Presentation for the First Half 2022 ended 31 March 2022 (Released on 27 Apr 2022)
3. Occupancy Level
The assets under management with 100% occupancy rate or above average industry occupancy level suggest its attractiveness to the tenants and the proactiveness of the REIT manager.
FCT has a healthy retail portfolio occupancy level at 97.8%. Most of the properties are close to 95% occupied except for the office property, Central Plaza. An anchor tenant has exited the office premise before 31 Dec 2021 bringing the occupancy level to 71.7%. FCT has managed to bump up the occupancy level by 5.6% from 71.7% to 77.3% as at 31 Mar 2022.
Source: Slide 15 of Financial Results Presentation for the First Half 2022 ended 31 March 2022 (Released on 27 Apr 2022)
4. The locational attributes of the properties
For example, if the REIT owns retail malls, it is critical for them to be easily accessible being near transportation nodes like MRT and bus interchanges which would mean there is usually a high pedestrian flow which in turn increase the chance of spending by customers.
In the case of FCT, the suburban malls owned (view map below) are well located as they are either next to MRT or within walking distances and near high-density housings. Suburban malls are also more resilient as they have a large catchment of locals residents hence not so dependent on tourist compared to shopping malls in town areas. Locals likely will still frequent the suburban malls for essential services during a recession.
Source: Page 3 of Frasers Centrepoint Trust 2022 Investor March 2022 Presentation
5. Choose a REIT with a strong sponsor
Most of the Singapore REITS are supported by a sponsor. The sponsor usually injects their own properties into the initial portfolio of the REIT when listing on the stock exchange.
Most of the time, such REITs are granted a right of first refusal to the Sponsor’s assets, enabling the REIT to leverage on the Sponsor’s strong network and pipeline of assets. When the Sponsor wants to sell its property asset, the REIT will be offered the right to purchase the asset first before it is being offered to the market.
A strong sponsor provides opportunities to grow the REIT by making new acquisition of new assets or making Asset Enhancement Initiatives (AEI) to existing properties. Investors should examine if the REIT has a track record of growing the DPU through acquisitions of new properties or making AEI.
History has also shown that most REITS with a strong Sponsor were better positioned to withstand the difficult times through their Sponsor’s support in terms of rights issuance or to obtain favorable interest rates for loans.
FCT is managed by Frasers Centrepoint Asset Management Ltd, a real estate management company and a wholly owned subsidiary of Frasers Property Limited. Frasers Property Limited is perceived as a strong sponsor being listed on Main Board of the Singapore Exchange Securities Trading Limited and has total assets of approximately $40.3 billions as at 30 Sept 2021.
The latest acquisition by FCT was remaining stake in AsiaRetail Fund Limited in Sep 2020 was DPU accretive which bring cheer to investor’s wallet.
6. Yield of the REIT should be more than 6%
Personally, I will only look at REITS that have yield of more than 6% as anything lower than that will lose its attractiveness to investors as they can find comparable yields in instruments like bonds.
I may consider REITS of 5% yield only if they are very stable and have a track record of increasing their DPU among other factors. It also depends on the type of REITS that I hold. Hospitality and offices which are more cyclical in nature, I would prefer it to have a yield of around 8% or more as their income will fluctuate more as compare to a healthcare REIT.
Our risk appetite are different so some investors may demand an even higher yield across different type of REITS.
Don’t chase after high yielding REITS as there are reasons why some offer higher yield than the others. Some of them are not well received because they have a history of falling DPU or they are currently facing some issues such as tenant default, termination of leases by tenants and etc. It is critical for a REIT investor to find out the story behind a high yielding REIT before investing your hard earned money in it.
Based on the recent transacted price of $2.43 for FCT and 2021 DPU of $0.12085, the yield is around 5% which seems reasonable but not very attractive.
7. Gearing ratio
Gearing ratio is the ratio of a REIT’s total borrowings to its total assets. As Real Estate Investment Trusts (REITS) have to distribute at least 90% of their income, it is hard for them to retain cash and hence they will need to take on debts. A high gearing ratio will mean more risk to the DPU as it imply higher interest expenses when financing cost rises.
Highly leveraged REIT may also find it hard to fund an acquisition of potential property without turning to placement, rights etc. In Singapore, REITS have a limit of 50% in gearing ratio.
A gearing ratio below 35% will be safer in my view. If the cost of debt is very cheap with a low effective interest rate, leverage of below 40% is acceptable as well.
FCT has a current gearing ratio of 33.3% which gives them sufficient headroom for future acquisitions.
8. Interest Coverage Ratio
The Interest Coverage Ratio (ICR) measures the ability of a REIT to repay its debt obligations, as to how many times its earnings can cover the interest expenses. ICR is calculated by dividing the Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) over the interest expenses. Below shows a formula of ICR.
There are some variations though such as from Monetary Authority of Singapore which defined the ICR as trailing 12 months EBITDA (exclude effects of fair value gain from derivatives and investment properties and foreign exchange translation) divided by the trailing 12 months interest expenses and borrowings-related fees.
Most industry experts will agree that an ICR of over 5 as safe for the REIT.
As of 31 Mar 2022, FCT has an ICR of around 5.72 times which does meet the safety checkbox.
9. Land tenure of properties whether leasehold or freehold.
Whether the properties are leasehold or freehold, money has to be spent to upkeep the properties. But for leasehold properties when the lease run up, the REIT manager has to top up the leases to the land at a cost. If lease top ups are not allowed, they may have to dispose them or if they continue holding it till lease expiry will face a decrease in the rental income when the lease ends.
Typically, a good REIT manager will sell off the short lease property property at a gain then deploy the proceeds into a freehold property or a longer leasehold property at good locations. Hence, I tend to prefer properties with long leases or properties that are freehold.
FCT has a Singapore retail portfolio that comprises 9 suburban retail malls and 1 office property at Central Plaza. FCT also owns 31.15% in Hektar REIT which consists of 6 shopping centers (include a mixed retail with hotel) in Malaysia. Below table shows the average land leases left of around 70 years for the Singapore portfolio (exclude Malaysia portfolio). The long land leases is a positive for me.
Source: Table computed by sggirlinvests.com with information taken from FCT website.
10. Whether the current price is significantly above the Net Asset Value
In the event the REIT is liquidated, unitholder should get back monies similar to the Net Asset Value (NAV) per unit. Hence, REIT investor should be cautious if the REIT is trading at at a price that is significantly higher than the NAV.
NAV Per Unit = (Assets Market Value – Liabilities Value) ÷ Number of Units
FCT has a current NAV of $2.31 which is close to the transacted price of $2.43 which suggests the price is not cheap but not too overvalued.
Concluding Remarks
Above are salient factors in my checklist when investing in REITS with Frasers Centrepoint Trust as an example. There are other considerations as well. Please conduct your own research before investing in REITS.
Disclaimer: I own units of Frasers Centrepoint Trust.
A Real Estate Investment Trust (REIT) is an investment vehicle that invests in a pool of real estate assets. These assets generate revenue by collecting rent from the tenants. Typically, 90% of the profit after deducting expenses and manager fees is then distributed to REIT unit holders on a quarterly or half yearly basis.
5 reasons to invest in REITS:
1. Offers you a better return
The average yield of the Singapore REITs and property trusts is 6.4% which is much more attractive compared to the 10 year government bond of 1.8%. Fixed deposit and interest rates are not indicated below but if you google for the current rates, it is around a meagre 1% or less.
REITs also provide a good hedge against inflation with a yield spread of about 4.3% (Reits average yield at 6.3% minus MAS core inflation rate at 2.1%).
Source: SGX Research Chartbook (SREITS & Property Trust)
2.Easier to understand as compared to stocks
If the REIT own local assets, you could do a physical viewing of the properties. Take for example, if you invest in a retail REIT like Frasers Centrepoint Trust that owns local shopping malls such as Causeway Point and Northpoint City North Wing amongst many others, you can frequent the malls during the weekdays and weekends to observe the footfall. A crowded mall would mean the shop owners or tenants are doing well as shoppers are consuming their services or purchasing goods from them. The tenants will in turn be able to pay their property rental which flows into income for the REIT unit holder.
Image: By StockSnap from Pixabay
Besides physical viewing of the properties, you should look at the financial ratios of the REIT such as occupancy rate of the property and the rental reversion (A metric captured by some REITs to show whether new leases signed have higher or lower rental rates than before) that is normally found in their annual reports and quarterly presentation slides to help to gauge if the properties are sought after. Other critical financial factors like the gearing of the REIT, cost of debt and land lease of the assets should be found in their presentation slides as well. Studying these factors are even more paramount if the assets own by the REITs are situated overseas.
In comparison, there are more variables in assessing a stock. Potentially, there are a lot of competitors and more disruptions to the business model. Like how Google disrupt Singapore Press holdings, Tik Tok compete with Facebook and Grab with conventional taxi companies such as Comfortdelgro.
3. Tax-exemption
A REIT listed on the Singapore Exchange is exempted from tax by Inland Revenue of Singapore (IRAS) under the tax transparency treatment as as long as the REIT distribute at least 90% of their income each year. Unit holders will benefit as this will lead to a higher distribution income for them.
4. Professionally managed
Within a REIT structure, there are conventionally a REIT sponsor, Trustee, a REIT Manager and a property manager. The presence of the REIT manager is to set and execute the strategic direction of the REIT. It is responsible for the acquisition and divestment of the property. It usually appoints a property manager to rent out and maintain the property. Investors do not need to worry about the upkeep and daily maintenance of the property in contrast to owning a physical property like a condominium or commercial office.
A good REIT manager with a strong sponsor will also help to grow the REIT by making acquisitions that are Distribution per Unit (DPU) accretive. Investors will thus have an increased yield on the cost of their REIT investments.
5. Liquidity
You can buy and sell units of a REIT easily as they are traded on the Stock exchange. Whereas for a physical property, it can take months to find a willing buyer or a seller, not mentioning the substantial commissions, fees and taxes involved in the transaction.
Disclaimer: I own units of Frasers Centrepoint Trust.
