More often than not, investors investing in real estate investment trusts (REIT) tend to pay closer attention to two valuation metrics, price/net asset value (PNAV) and distribution yield.
While these metrics are not only easy to measure, they are also extremely useful when used appropriately: There are however other aspects which an investor could include in their arsenal when evaluating REITs as we explore them.
Industry Profile
The maiden step for an investor to take is to identify the industry which the selected REIT is in as well as to understand the nature of the industry.
Some industries operate in business environment which are more cyclical than others, for instance, commercial and industrial REITs tend to be more adversely impacted during economic slowdowns compared to healthcare REITs.
One can rationalise by understanding that a business has the option to scale down its operations and expenditures during challenging times, however, healthcare services are necessities for everyone regardless of economic health and therefore healthcare REITs tend to be less cyclical.
Nonetheless, the opposite can be applied during times of optimism as cyclical REITs can negotiate for higher rental reversions.
Having mentioned earlier on that valuation metrics can only be useful when used under the right conditions, this is especially true in this context.
For example, a cyclical REIT’s distribution yield could be higher than another that is non-cyclical. This is by no means a signal of undervaluation since the cyclical REIT’s share price could have fallen, while the higher distribution yield encompasses the risks involved. As such, investors should take note of this.
Ascendas REIT is one of the
highest yielding REITs in the
table above.
However, when tabulated against its
industry, Ascendas REIT is the
lowest yielding.
Gearing And Debt Maturity
Next, the gearing and debt profile of a REIT should be closely examined. Gearing is defined as the amount of both long and short-term debt used to finance assets held in a REIT’s portfolio. Under Singapore’s regulations, a REIT which discloses a credit rating from any of these credit rating agencies (Fitch, Moody’s and Standard & Poor’s), will have its gearing ratio capped at 60 percent, compared to 35 percent for those which do not.
One can simply look at this ratio as a lifeline of the underlying REIT. REITs with higher gearing have a significantly larger amount of debt on its balance sheet and this could cause difficulties in refinancing during economic slowdowns as financial institutions tighten their lending (may lend but at a much higher interest rate).
As a result, a REIT manager who is unable to refinance its bank loans, may have to perform rights issue in order to secure financing which most likely would dilute an investor’s existing position, if the rights are not subscribed. In more detrimental circumstances, properties may have to be spun-off to raise funds.
In addition, an investor should also pay attention to a REIT’s debt profile (cost of debt and maturity). If a REIT has a significant proportion of its debt which are expiring and are not re-financed, one has to analyse whether it is due to difficulties faced by the REIT manager in re-financing their loans.
Debt maturity profile of Sabana REIT – 37 percent of its debt is expiringin 2015,
while another 31 percent is expiring in 2017. If its REIT managercan’t expedite
re-financing in time, alternative sources of financing would
need to established.
Else, a similar outcome will pan out where the manager has to tap on other sources of financing.
Even when loans are refinanced, an investor should also seek to understand the cost of debt or interest rates involved during re-financing.
Occupancy Rate And Lease Expiry
The third aspect to look into is a REIT’s occupancy profile. Beyond the REIT’s overall portfolio occupancy rate, an investor should also look out for a diversified tenant pool which reduces the volatility of rental revenue during unexpected circumstances.
If a REIT’s portfolio is heavily exposed to a specific sector, a slowdown in that particular sector could potentially cause rental revenue to spike down.
In addition, a REIT’s lease expiry profile should ideally be longer-term or at least well-staggered.
This is because a concentrated amount of lease expiry in a particular period could signal potential difficulties a REIT manager may face while securing new leases.
Lease expiry profile of Mapletree Logistics – most of its leases are well
staggered with more than 30 percent of which are expiring beyond
2019, providing the REIT manager ample time to secure
the best rates.
Lease expiry profile of Sabana REIT – more than 50 percent of its
leases are expiring within one year in 2015. REIT manager may face
obstacles in rental reversions.
There is no doubt that the aforementioned requires a fair bit of research, however, considering that these sources are easily accessible on a REIT’s financial statements and website, a potential investor is encouraged to perform his or her due diligence before initiating any positions.
We will end off with a quote from Warren Buffet “Only when you combine sound intellect with emotional discipline do you get rational behaviour,” by performing due diligence, one has fulfilled the aspect of sound intellect, and is one step closer in establishing a rational behaviour, which is ultimately crucial for successful investing.