Guide to Analysis of REITs

A look at factors to analyse before investing in REITs

If you already know a thing or two about REITs, you would still need to do your due diligence in considering the current S-REIT climate and analyse S-REITs quantitatively and qualitatively.

“S-REITs no longer as expensive as compared to Nov-19 but still not at bargain prices seen during the Global Financial Crisis period”

Glossary of S-REIT Terms

Accretive Acquisition

- aka "yield-accretive acquisition", is purchase of an asset leading to increase in acquirer's distribution per unit (DPU).

- In most M&A, acquirer REIT will use debt & equity to fund the acquisition

- Acquisition has to be accretive / result in increase in DPU

- Opposite of a dilutive acquisition

Average interest cost

- Shows how expensive borrowings are

- Important as REITs are leveraged products that depend on high levels of borrowing to fund property acquisitions

- REITs generally benefit in a low i/r environment like the current one

- Even with a low i/r environment, when the operational profile of a REIT deteriorates causing a credit rating downgrade, REIT might see increased interest cost

Aggregate Leverage/Gearing

- Important factor that has often been scrutinised

- Gearing = Total Debt / Total Assets

(Denominator is usually total equity for non-REITs)

- MAS imposed a gearing limit of 45% for all REITs in 2015. Limit is now 50% due to Covid-19

Base Fee

- Fee REIT pays to the REIT manager regardless of REIT performance (0.25 to 0.5% of total assets of REIT)

- Could cause conflict of interest between RM & UH as RM is "incentivised" to grow total assets perhaps via new acquisitions despite acquisitions not being favourable / accretive acquisitions

Capital Expenditure (CAPEX)

- Refers to cost incurred to acquire, maintain, or upgrade assets like property, plant, & equipment (PPE)

- Could include asset enhancement initiatives (AEI) to refurbish properties

- Upgraded property attracts more tenants, resulting in higher rental price

Capitalisation Rate (Cap rate)

- Cap rate = Net Operating Income / Purchase Price

- Higher purchase price → lower cap rate (vice versa)

- When buying property, the acquirer will prefer a higher cap rate which indicates higher potential returns

- When selling property, the seller pushes for a low cap rate as it means a higher purchase price

Cost of Capital

- Cost to REIT for raising capital in the form of equity & debt

- Cost of Capital = (funding by equity% * cost of equity) + (funding by debt% * cost of debt)

- Cost of equity generally includes dividend rate & expected equity growth rate

- Cost of debt is interest cost on the debt incurred

Distributable Income (DI)

- Normally calculated from "Income available for distribution"

- In theory, DI must be at least 90% of income available for distribution to enjoy tax-exempt status

- In today's context, many S-REITs choose to pay out 30-50% due to Covid-19 to build up reserves in anticipation of a deterioration in its operating environment ahead

Distribution per Unit

- Amount of dividends UH receives per unit

- DPU = Distributable income / Total Number of Units outstanding

- In some sense, DPU is more important than DI as DI can increase due to property acquisition

- If acquisition is funded by equity (which increases total number of units outstanding) DPU might be lower as rate of DI increase is lower than the rate of increase in units outstanding

- This happens when the acquisition is dilutive

Distribution Yield

- Aka yield on cost

- Distribution Yield = DPU / cost of each unit of REIT on an acquisition

- Higher DY → more attractive REIT

Gross Revenue

- Total revenue collected from REIT assets including gross rental income, car park income, etc

Income Available for Distribution

- Generally calculated as net income + other non-cash components like depreciation & amortization, future income tax expenses, & gain/losses in the revaluation of the property - sale gain from the property

- Key component that UH tracks when evaluating the attractiveness of REIT

- Similar to term funds from operation / FFO ( commonly used in US to define cash flow)

Net Asset Value (NAV)

- Book value of REIT

- NAV = market value of assets - liabilities & obligations

Net Property Income (NPI)

- Amount that measures property's profitability after deducting property expenses like property manager's fee, property tax, maintenance expenses

- Net Property Income = Gross revenue - Property Expenses

- Note that NPI is different from net income as net income still deducts other non-property related expenses like borrowing costs & RM fee from NPI

Occupancy Rate

- Measures proportion of lettable area occupied by a tenant

- Handful of REITs can have relatively high occupancy rates of 95% & above

- High rate indicates highly desirable properties but is a double-edged sword in a booming market where rental rates increase & property with close to full occupancy cannot benefit

Property Yield

- Often defined as NPI from all properties / Total value of property

- High ratio indicates that properties are potentially "undervalued" & more desirable

REIT Manager/management fee

- RM is like the fund manager & tends to make investment decisions like acquisitions & divestments of properties on behalf of UH

- Hires PM who is like the facilities manager in charge of maintaining & operating the properties

- PM fees are expenses used to calculate NPI from Gross Revenue

- RM fees are non-property expenses used to calculate net income from NPI

Rental Reversion

- Shows whether new leases signed have higher / lower rental rates than before

- No standardisation across industry as to how rental reversion is being calculated

Revenue per Available Room (RevPAR)

- Used in the hospitality industry to measure the average amount a hotel makes per room

- RevPAR = Hotel's total revenue from rooms available / Number of days being measured

Sponsor

- Previous owner of properties in REITs that has now "monetised" them by injecting properties into a REIT

- May continue to provide a pipeline of assets for the REIT

- Tends to own stakes in RM & the REIT itself

- Strong sponsors provide future growth visibility

- In cases where the sponsor is also the master lessee of REIT, a strong branding + credit rating of the sponsor gives UH confidence of high level of revenue visibility

Triple Net Lease

- Lease agreement where tenant agrees to pay RE taxes, property insurance, building maintenance costs, utility expenses & their monthly rentals

- Beneficial to REIT to not bear operating costs of the property

- UH should pay attention to REITs where such triple net leases are derived from the sponsor (Could be a method to increase property values when these assets were injected into the REITs, thus benefiting seller/sponsor)

Weighted Average Lease Expiry (WALE)

- Measures length of property leases

- Long WALE is better as they provide a higher degree of revenue visibility over mid-term

- Short WALE properties might face difficulties in time taken to find new tenants if lease if not being renewed, which affects occupancy rate

1. Using net lettable area (NLA)

Property 1: 30% of area expiring in 5 years

Property 2: 70% of area expiring in 10 years

WALE (NLA) = (30% * 5 years) + (70% * 10 years) = 8.5 years

2. Using Gross Income:

Property 1: 40% of gross rental income with 4 years of remaining lease term

Property 2: 60% of gross rental income with 8 years of remaining lease term

WALE (Gross Income) = (40% * 4) + (60% * 8) = 6.4 years

Current REIT Environment

Are REITs Expensive Today?

- In Nov 2019, months before the pandemic began, S-REITs traded with a forward yield of 5.3% which is close to -2SD

- Definitely "not cheap" on a yield basis. It was as high as 7.5% back in late-2011 & late-2015

- On a forward Price to book basis, it traded at 1.15x, close to +2SD above its 8-year mean

- Yield spread ( difference between FSTREI & SG govt 10Y bond yield) was 3.5%, which is at -1SD. The average historical yield spread was 4.2%

- All metrics pointed to over-valuation yet research then indicated that buying REITs even when they look "over-valued" does not necessarily indicate it will be a bad investment based on their historical performance

- Despite assuming that buying into FSTREI in Jul 2013 & holding till end 2019, when it was overvalued, it rose by 18% while STI index is marginally negative

- 2.8% annualized capital appreciation coupled with yield on cost of 4.2% thus total annualised returns is 7%(Not too bad. This is when you are buying REITs when they are EXPENSIVE)

- REITs' valuation now after sell-off: According to RHB Research, S-REITs yield closer to 6.5% now

- Yield spread is 5.5%, above average of 4.2% & comes close to +1SD level of 6%

- S-REITs hit 6% back in March at peak of sell-off but prices have since recovered

- On a price to book basis, S-REITs are now at about 1x PBR, the 8-year average level.

- As such, S-REITs no longer as expensive as compared to Nov-19 but still not at bargain prices seen during the Global Financial Crisis period

Should One Invest in REITS Now?

- Many REIT industries now face operational challenges that could have a lasting impact on businesses in the mid-term.

- Hospitality REITs are likely to see a prolonged drop in tourist arrivals affecting occupancy.

- High-end retail malls like Paragon (owned by SPH REITs) will see a drop in retail purchases fuelled by rich tourists with decline in medical tourism as well

- Office REITs might see lower demand as companies get more accustomed to the idea of employees working from home

- Industrial REITs might be slightly more insulated, but not immune with many SMEs potentially going belly-up

- More resilient REITs are Healthcare & Data Centre, which encompass only 3 S-REITs

- S-REITs near-term fundamentals are negatively impacted & some of weaker REITs might not survive

- Suggestion: avoid chasing high yield REITs that might prove transitional. Look for bargain purchases on blue-chip REITs

- For those heavy in REITS, trim exposure to REITS & possibly hold some cash to wait for a better entry point to reinvest capital

- For those with existing REIT counters & a long investment horizon, remain vested in REITs as this investment class will continue to be a good source of passive income in a recession, but re-evaluate your portfolio & get out of counters that look attractive on a "yield basis" but has extremely weak balance sheets

- Those without REITs, this might be the time to get started, but do it strategically: identify quality blue-chip REITs & spread out your entries

- Bottom-line: REITs continue to be a relevant investment class & will not disappear because of Covid-19 (although some names might)

- At the current level, yield spread indicates a certain level of undervaluation

- Choosing REITs which can withstand economic drawdown from a prolonged health pandemic will ultimately reap strong returns

What Happens with a Recession?

- No doubt that SG will see / is already in a recession in 2020

- US govt has taken a dovish stance by driving short-term i/r down to 0

- But, fiscal stimulus engaged by govts worldwide is unlikely to be enough to offset negative impact on businesses

- That is where monetary stimulus / helicopter money comes in. It is too early to tell how this will end up and if throwing money at consumers will lead to consumption to kick-start the economy

- Reality now is that businesses will get impacted & tenants will start negotiating for lower rentals

- Occupancy could drop significantly, hitting both top and bottom-line performance of REITs

- Positives from lower i/r might be insufficient in combatting overall decline in earnings (lower rentals / occupancy)

- “if a recession is to occur, REITs, like most asset classes, will be negatively impacted. But, drawdown will be partially negated by the lowering of i/r. REITs with long WALE and floating loans will benefit from such a scenario".

- But, statements on floating loans might be irrelevant, if the credit rating of REIT declines

- High level of floating loans will only benefit best of blue-chip REITs which can refinance at lower i/r as their credit rating has remained

- For smaller to medium-size REITs, high level of floating loans might lead to higher cost of borrowing despite lower i/r as weakening of their biz fundamentals leads to a cut in their credit profile

- E.g. Frasers Centrepoint Trust used to be able to issue fixed-rate notes at 2.6-2.8% before a downgrade in credit rating

- As of 30 April, the REIT highlighted that it issues notes at a rate of 3.2%

- Below is a summary of S-REIT balance sheets & debt status from RHB

- RHB also provided a forecast for % of asset value decline before REITs breach 50% gearing limit

- Higher ratio is better. This has to be taken with operational outlook of individual REITs itself

- Bottom-line: Blue-chip REITs with good & stable credit standing will benefit from a lower i/r & in this case, having a high level of floating debt is ideal

- REITs should also have unencumbered assets (like CapitaLand Mall Trust at 100%) which increases financial flexibility

- These are most likely to survive a recession. Look to capitalise on share price weakness on sell-downs

New Measures to help REITS Navigate Challenges

- 1 April: SG govt introduced a temporary bill to suspend enforcement actions by commercial landlords against tenants unable to pay rent for up to 6 months (potentially extending to 12)

- Concern: REITs unable to collect rentals from tenants for up to 6 months & many could default

- REITAS on April 6 voiced to the govt that such enforcements could jeopardize long-term health of S-REITs & SG’s attractiveness as a REIT listing venue

- Seems that few tenants are "taking advantage" of this new bill & requesting for deferment of their rentals, according to Frasers Centrepoint Trust

- Govt is helping alleviate financial constraints of REITs with new measures (16 Apr)

Key points:

1. Extension of permissible period for distribution of taxable income

- MOF & IRAS will extend the timeline for S-REITs to distribute at least 90% of taxable income from 3 months to 12 months to qualify for tax transparency

- Extension gives S-REITs more flexibility to manage cash flows

- As S-REITs typically distribute bulk of income to UH, they tend to hold lower cash reserves

2. Higher leverage limit & deferral if interest coverage requirement

- MAS raised the leverage limit for S-REITs from 45 to 50%

- S-REITs will have greater flexibility to manage their capital structure

- MAS will defer implementation of new min. interest coverage ratio (ICR) requirement to 1 January 2022 as S-REIT ICRs will be negatively affected

- Last year, MAS had proposed to require S-REITs to have a min. ICR of 2.5x before being allowed to increase leverage to beyond prevailing 45% limit (up to 50%)

- S-REITs have access to different funding channels, like borrowing from banks, issuing bonds, & raising equity as a result of higher leverage limit & enhanced share issue limit announced by SGX RegCo

- Bottom-line: REITs are not expected to bear full-brunt of SG economy lockdown

- While most REITs will see reduction in their DPU for 2020 at least, decline in DPU trend this year is not expected to be a permanent feature 2021 onwards

- New measures implemented provides REITs with some breathing space for their financials & imminent "need for capital raising"

- REITs go into this recession with a much stronger balance sheet as compared to GFC

- In GFC, banks were unwilling to refinance companies with a weak balance sheet & REITs had to use equity-raising which further pressured share prices

- With this recession, however, our local banks are in a much stronger financial footing to support companies for refinancing, albeit potentially at a higher interest cost

- Blue-chip REITs with a strong balance sheet will not face the issue of refinancing risk in this recession

Current REIT

- REITs are no longer as "expensive" in terms of valuation metrics like P/ book and yield spread as compared to end-2019

- But short-term fundamentals of most S-REITs have been impacted & should be taken into account when evaluating attractiveness of REITs at current price

- Compared to the GFC period, share prices have not declined significantly even at the worst point in March 2020

- But S-REITs are in a much stronger position coming into this crisis with balance sheets & not being significantly geared

- Banks are in a strong position to refinance REITs & govt has new measures to help REITs & tenants

- See refinancing risk as relatively low for blue-chip REITs, with some benefiting from lower refinanced costs due to strong credit rating profile & strong business fundamentals

- By sectors, Industrials, Healthcare & Data Centre looks to be the best positioned to ride out the crisis unscathed

- Retail & Hospitality could ultimately see some casualties

- Outlook for OREITs is generally more neutral in the short-term

- Changes in company operations (work from home policies etc) could pressure mid to long-term outlook of OREITs

Quantitative REIT Analysis

- These 10 factors will give a quick & easy solution to identify undervalued S-REITs, based on business fundamentals & "price attractiveness"

- Each metric has a weightage e.g. 18% (more important) vs 5% (less important)

- Each metric graded from 1 to 5 (3.5 & above good enough for consideration)

1. No. of Years with Net Property Income (NPI) Growth

- NPI = Gross revenue - (property maintenance fees + property taxes + other operating expenses)

- Shows how well REIT assets are performing & the rise/fall in their associated costs

- Quick overview of how the REIT can grow its revenue, be it from higher rentals / acquisitions

- Steady rising NPI growth every year illustrates ability to grow revenue by rental hikes which is a good sign

- E.g. below, Ascendas REIT has 4 years of YoY NPI growth (5 points)

- We associate 10% weightage for this

2. No. of Years with Distribution per Unit (DPU) Growth

- Amount paid out as dividends to UH

- REIT's ability to manage its finance cost, RM fee & other non-property expenses translates NPI growth into DPU growth

- NPI growth DPU growth may not always coincide due to changes in finance cost

- E.g. Ascendas REIT has been able to translate 4-year consecutive NPI growth into DPU growth, hence 5 points.

- 18% weightage for this metric

3. Portfolio occupancy/revenue per available room

- Occupancy close to 100% is highly sought after & commands a rental premium / a positive rental reversion in the next lease cycle

- Low occupancy rate means difficulties in leasing out units, might translate to a rental discount

- But, 100% occupancy with a long WALE (leases are locked in) leads inability to take advantage of a rising rental market

- E.g. Ascendas REIT, portfolio occupancy is weak at 90.9% caa Dec 31, 2019, hence, 1 point

- Might be unfair to penalize if it is associated with a strong rental reversion trend

- 8% weightage

- 8% for hospitality REITs, but portfolio occupancy is replaced by Revenue per Available Room (RevPAR)

4. Portfolio weighted average lease expiry (WALE)

- How long properties are leased out for

- Long WALE gives investors' assurance of revenue stability

- Short WALE might present concerns over rental renewal

- WALEs in SG are typically shorter than US, AUS, UK, or Europe

- Long WALEs typically have a rental escalation clause in the contract to ensure a certain level of revenue growth visibility

- E.g. Ascendas REIT, portfolio WALE is 3.9 years caa 31 Dec 2019, thus 3 points

- 8% weightage

5. Gearing Ratio

- Total borrowings ÷ total assets

- MAS has set leverage ceiling to 50%

- E.g. Ascendas, gearing ratio is 35.1%, thus 3 points

- 15% weightage

6. Interest Coverage Ratio

- Measures no. of times EBITDA (earnings before interest, taxes, depreciation & amortization) can cover interest expense

- Interest coverage ratio of 3x is the benchmark to cover fixed charges

- High-interest coverage ratio might be able to help compensate for the "relatively" higher gearing ratio (lender will take this into consideration when evaluating credit risk of REIT)

- E.g. Ascendas REIT has interest coverage ratio of 5.4x (average) hence, 3 points

- 10% weightage

7. Interest Cost

- Demonstrates ability to secure cheap funding

- Ties back to resilient-nature of its business

- E.g. Keppel DC REIT has very low interest costs at 1.9%

- Typically, REITs with assets based overseas can secure a much cheaper cost of debt

- However, REITs that already enjoy a low cost of debt might not be able to benefit further from a lower-trending interest cost environment

- E.g. Ascendas REIT’s cost of debt, 2.95% is only slightly lower than sector average 3.2%, hence, 3 points

- 6% weightage

8. Average of Top Property & Top Tenant Contribution

- Avoid concentration risk

- E.g. Mapletree North Asia Commercial Trust was badly hit when key property, Festival Walk (64% revenue), was damaged during the HK protests

- Same can be said for key tenant that encompasses a huge proportion of a REIT revenue

- E.g. Ascendas REIT average % for this diversification metric is a low 4.9% hence, 5 points

- 8% weightage

9. Price to NAV

- Considers REIT valuation market cap over its net asset base

- REITs are all asset-heavy, so an asset-light REIT would seem over-valued based on its price-to-book ratio

- Multiple above 1x might indicate a certain level of over-valuation but not necessarily mean a poor investment

- Notice many bigger blue-chip REITs trade more than 1x book while smaller-cap trade at a discount to their book

- E.g. Ascendas trades at 1.11x P/NAV with S-REIT averaging 0.67x (one of the lowest seen in years) hence, 2 points

- 5% weightage

10. Distribution Yield (DY)

- High DY REIT counter is more desirable but has to be evaluated with sustainability of such dividend payments

- E.g. Eagle Hospitality Trust DY is 43% due to its significant share price correction in recent days

- One must evaluate the feasibility to continue the same DPU payment at 43% DY but it is hard to do so without a DPU track record

- E.g. Ascendas REIT DPU payment has been extremely stable, with consecutive DPU growth over the past 5 years (Metric 2)

- Hence, more assured that Ascendas DPU can be maintained

- Ascendas REIT DY is 6.5%, hence 3 points

- 12% weightage

Conclusion on Ascendas

- Ascendas REIT’s total weighted average score is 3.51, narrowly qualifying for our consideration list in this example

- Hence we move on to evaluate REITs on qualitative factors

Qualitative REIT Analysis

- These 8 factors are much more subjective, hence time consuming, to analyse than quantitative factors

1. Benefits of A Strong Sponsor

- Look for REITs backed by strong sponsors who are property developers with excellent credit ratings

- E.g. Mapletree-Group REITs, Keppel-Group of REITs & CapitaLand-Group of REITs have strong sponsors

- E.g. of poor sponsor: First REIT share price collapsed in late 2018 when its main revenue contributor (concentration risk) & sponsor, Lippo Karawaci saw its credit ratings being downgraded by Fitch from B to CCC+ due to concerns over liquidity risks & alleged bribery linked to one of the Lippo Group's assets

- Hence, despite First REIT ranking well quantitatively (score of 3.8) & being in the healthcare sector, its sponsor factor makes it avoidable

- Strong sponsor will encompass a strong pipeline of assets for future growth & give REIT access to valuable assets via a robust pipeline of quality asset injections

- REITs are not obligated to purchase these assets but will usually have first rights of refusal (serves as a ready source of inorganic growth for REIT)

- Strong sponsor will also provide a certain level of corporate governance assurance & financial backing for REIT in event of a crisis

2. Sustainability of DPU growth/DPU support

- Evaluate how DPU growth/decline might materialize in the future

(i) Yield accretive inorganic acquisition

- Despite higher share base (due to rights issuance), overall yield on a DPU basis can still grow if yield accretive assets were being acquired

(ii) Positive Asset Enhancement Initiatives

- REIT engages in AEI on properties, allowing REIT to charge higher rental rates to tenants

- Look out for properties that might be currently doing major AEI works on key properties

- Might hurt DPU in the short-term but could result in DPU growth in mid & long-term

(iii) Reduction in interest costs

- As highly leveraged assets, reduction in interest costs on borrowings will significantly improve profitability & thus, distributable income.

(iv) Increase in Managers' fees payable in units

- E.g. Capitaland Commercial Trust's management fees are fully paid in cash

- If biz sees a dip, REIT can choose to partially / fully convert to unit payments

- Conserve cash & ensure that REIT can continue to grow its DPU

(v) Loss of DPU Support

- DPU support from sponsor / significant shareholder

- In the first few years of listing, strategic investors might not be eligible to take dividend distributions (this info can be found in the prospectus)

- This increases overall pool of distributable income to minority UH

- Once the lock-up period has lapsed, there is a sudden & huge decline in distributable income to minority UH

E.g. BHG Retail REIT initially, 30% of UH (strategic investors) are not entitled to any distributions, by 5th year, ratio declines to 5%

3. RM Remuneration (fee) scheme

- Track a REIT's DPU growth trend relative to manager fees growth to see if RM’s interest is aligned with UH

- If DPU has grown consistently, it is fair for RM fees to grow at the same rate

- Performance fees based on Gross Revenue & NPI growth can result in overcompensation

- Recall that NPI growth might not lead to DPU growth (due to management fees & finance cost etc)

- Where performance fee is not pegged to DPU growth there might be a conflict of interest

- Most of REITs have a manager payment schedule with asset management fees as a % of distributable income from operations (based on 2019) between 10-15%

- Avoid some outliers with fees crossing 15%

- Those that pay management fees in cash (100 per cent), like CapitaLand Commercial Trust, Keppel DC REIT, Parkway Life REIT, CapitaLand Mall Trust, etc have flexibility to convert management fees payment partially/fully to units to maintain their DPU growth trend

4. Renter Reversion Trend

- Most will use this metric to forecast revenue growth

- Problem:not standardized across the industry

- +5% RR by Keppel REIT is different from +5% RR by Frasers Commercial Trust

- Keppel REIT calculates RR based on average rent of new lease period vs average rent of expiring lease period

- More conservative method: Mapletree Commercial Trust uses average rent of new lease period vs. LAST YEAR rent of expiring lease period, in a rising rent environment.

- Most conservative is comparing new first-year rent vs. last payable rent (Frasers Commercial Trust)

- Immediately see how actual cash flow will be impacted

- Using average rental of the new lease period "overstates" the income statement relative to cash flow as the "higher" average rental is not yet realised as cash flow

- E.g. 3-years lease, lease amount of $10 Y1, $10.50 Y2, & $11 Y3

- Previous 3-years lease was $8.50, $9.00 & $9.50 per annum

- By using new first-year rent vs. last payable rent, RR is ($10-$9.50)/$9.50 = 5.3%

- By comparing average rent of new period & average rent of the old period, RR is ($10.50-$$9.00)/$9.00 = 16.7%

- By comparing average rent of new period vs. last payable rent, RR is ($10.50-$9.50)/$9.50 = 10.5%

- Portfolio with 5% RR might not translate to a 5% increase in gross revenue on a YoY basis

- Useful to dig deeper into the RR methodology of REITs

- RR should be taken in context with occupancy rate (strong RR trend can offset low occupancy rate, weak RR trend can negatively offset high occupancy rate)

- E.g. Ascendas REIT has a relatively low occupancy rate but has strong RR trends (but use Method 2 in computation)

- Ascendas REIT can well-afford to lower rental asking price to "fill-up" properties to a higher occupancy level if it so wishes to

5. Frequency of Equity Raising vs Asset Raising

- Most REITs do not have spare capital to deploy to make new acquisitions due to 90% distribution of income

- Hence, equity raising is used to raise new capital for asset acquisitions

- With higher outstanding share base & if distribution income did not increase correspondingly, DPU decreases.

- Favour REITs that grow their income organically through AEIs, cost-management, etc vs.those that turn to capital market for equity to grow via inorganic means

- With RM fee tied to asset base, there is incentive for RM to acquire new properties, sometimes at the detriment of UH

- Less incentive for RM to divest assets as it will reduce overall assets

- Good RM will look at constantly recycling portfolio of assets, divesting assets with lower-than-average capitalisation rates

- This way, REIT does not need to turn to the capital market to raise funds

- E.g. Keppel REIT, in late 2019, divested Bugis Junction Towers for $547.5m, realizing capital gains of $378.1m, with proceeds giving financial flexibility to engage in buyback, acquisitions, debt reduction & distributions to UH

- But, they did not fare well in quantitative tests (3.04) due to inconsistency in NPI & DPU

- Also note that Keppel REIT has an extremely high management fee ratio, 25%

6. Access to Cash & Line of Credit Facilities/unencumbered Properties

- Gearing shows quick overview of leverage situation

- One must note REIT's outstanding access to cash & line of credit facilities provided by bankers

- REIT with "decent" level of gearing e.g. 35% is at high risk of running into funding issues if they have zero access to an additional line of credit facilities

- E.g. Ascendas REIT (gearing of 35.1%) has approx. $1.2 billion outstanding credit facilities available for drawdown (roughly 25% of current total debt)

- If insufficient, unencumbered properties as a % of total investment properties is at a high 91.8%, providing added financial flexibility to tap on secured borrowings, if required

- E.g. ESR-REIT gearing is 41.5% with 195m in debt headroom before hitting the 45% (now 50%) mandatory ceiling set by MAS & has undrawn committed facilities of only $90m left (caa end-2019)

- In today's context where "Cash is King", huge cash buffers increase chance of survival

7. Tenants Profile

- Diversification of tenants & asset is 1 key quantitative metric

- Level 2 analysis: evaluate asset/tenant profile in-depth

- Bankruptcy risk has increased with Covid-19

- Businesses without access to cash / with cash-flow problems might be at risk of insolvency & could default on rents

- Personally, single tenants with at least 10% of REIT revenue need to be assessed on systematic & industry level risks

- E.g. REIT might have exposure to Oil & Gas industry if many units are leased out to O&G clients

- Recent oil price collapse might once again (happened back in 2014-2015) putting O&G counters at risk of insolvency

8. Specific Industry Outlook

- Impact of covid 19 varies by industry

- Those who wish to “bottom-fish” hospitality REITs must look at balance sheet strength & access to capital

- Might be months before we tourism back to normal

- Suburban mall REITs like Frasers Centrepoint Point are seen as more resilient amid Covid-19 (although its share price has been heavily sold-off the past 2-3 trading days).

- high-end malls like Starhill Global REIT are highly dependent on tourist footfall

Determining Which Top S-REITs to Buy

Method 1. Select REITS Using REIT Comparison Table

- Top 10 REITs based on part 1’s scoring system:

Ascendas India Trust (Office + Logistics)

Ascott Residence Trust (Hospitality)

CapitaLand Commercial Trust (Office + Retail + Hospitality)

CapitaLand Mall Trust (Retail + Office + Logistics)

Cromwell European REIT (Office + Industrial + Logistics)

First REIT (Healthcare + retail)

Frasers Logistics & Commercial Trust (Industrial + Logistics + Office)

Keppel DC REIT (Data Centre)

Lendlease Global Commercial REIT (Retail + Office)

SPH REIT (Retail)

REITS to be Considered

- Large-cap: CapitaLand Commercial Trust & CapitaLand Mall Trust once combined, will be the largest S-REIT & enjoy substantial economies of scale & benefit from lower borrowing costs

- Small/mid-cap: Frasers Logistics & Commercial Trust with 86 properties is a worthy consideration candidate

- Keppel DC REIT, one of the most resilient REIT counters in today's context had done very well in our scoring system, largely due to its growth factor

- Cromwell European REIT is up for consideration, particularly after the worst of Covid-19 is over in EU

- Ascendas India Trust has significant geographical risk being based in India & is likely in the early stage of Covid-19, but its properties are mainly IT & logistic Parks (likely resilient) hence, worthy of a second look

- Lendlease Global has a very concentrated investment portfolio of only 2 assets, 313@somerset & 2nd Sky Complex in Milan (Grade A office in Italy). Downside: significant exposure to high-end retail

REITS Not Within Further Consideration

- SPH REIT article

- First REIT, while in an attractive industry has Indonesian exposure to Covid-19

- Avoid hospitality REITs like Ascott Residence Trust as there is still a huge amount of uncertainty about the resumption of the tourism/serviced apartment industry

- However, if the counter declines further, there could be bottom-fishing opportunities.

Method 2: Select REITS Using Price Fall Relative to DPU Decrease

- Select REITs via a combination of both price actions (how much the REIT has declined from its 52-week level) & REIT biz fundamentals (how much 2020/21 DPU is forecasted to decline from 2019/20 level by the street)

- Some argue greater fall in share price equates to more value but very often, larger than average fall in share price is due to counter's biz fundamentals being more significantly affected than its peers.

- E.g. CDL Hospitality Trust declined 45% from 52-week high, while Keppel DC REIT has only

- CDL Hospitality Trust is expected to see DPU slashed by 47% in 2020

- Keppel DC REIT is expected to grow DPU by 18%

- Might be a strong justification to purchase Keppel over CDL

- Based on this method, some of the REIT counters worthy of consideration include:

Parkway Life REIT

Keppel DC REIT

Ascendas REIT

CapitaLand Mall Trust

Mapletree NAC Trust

Starhill Global

CapitaLand Commercial Trust

Keppel REIT

Mapletree Commercial Trust

Method 3: Select REITS Using Street Recommendation & TP

- SGInvestors’s list of S-REITs with ratings & target price (average target price among brokers)

- Top 5 REITs with highest TP upside based on the street estimates are:

Lippo Malls Indo Trust (1 Analyst coverage with 1 Buy rating) - Upside: 65.5%

ARA US Hospitality Trust (1 Analyst coverage with 1 Buy rating) - Upside 64.7%

Lendlease Global (1 Analyst coverage with 1 Buy rating) - Upside 63.5%

Manulife US REIT (4 Analysts coverage with 4 Buy rating) - Upside 49.3%

ESR REIT (4 Analysts coverage with 4 Buy rating) - Upside 49.3%

- Be cautious of REITs with only 1 analyst coverage with a high TP upside

Conclusion

- REITs as an investment asset class in SG will continue to remain as an attractive passive income option

- While the global REIT industry is undergoing its worst crisis since GFC, fundamentals of REITs in today's context are on a much stronger footing

- There is no certainty that all S-REITs will survive but blue-chip REITs will survive & emerge stronger as they capitalise on acquiring assets on the cheap

Disclaimer: This blog post's contents are from newacademyoffinance.com