What are Real Estate Investment Trusts (REITs)?
Real Estate Investment Trusts (REITs) are getting popular nowadays. For those who are not familiar with REITs, do read this article. For those who are familiar, this article will be a refresher and may have things that you never think of in the past.
Why and What?
In terms of capital, you can start investing in Reits from as little as $1000 as compared to real properties where you need at least 5-6 figures for the downpayment! Thus, it is a very affordable option for people who want to invest in properties for cashflow but only has limited funds.
To put in in very simple terms, in summary, REITs are
- popular investment options for those who are interested in real estate, but do not want the hassle of managing multiple properties themselves.
- investment vehicles that own, operate, and finance income-generating real estate properties such as apartments, hotels, office buildings, data centre, rural farms, shopping malls etc
- investment trusts that own, operate, and finance income-generating real estate properties. In return, REITs were required to distribute at least 90% of their taxable income to shareholders in the form of dividends, which mean cashflow for investors.
Advantages of Reits
- Diversification: REITs provide investors with exposure to a diversified portfolio of income-generating real estate properties unlike a single property for a real physical property that one purchase directly.
- Dividends: REITs generate income through rental payments and interest payments from real estate loans and they are required to pay 90%. This income is typically distributed to shareholders in the form of dividends, providing a steady cash flow.
- Liquidity: REITs can be easily bought and sold on stock exchanges (can even use RSP), providing investors with the ability to quickly liquidate their investments if needed. This is totally unlike a real property bought from the real estate market.
Disadvantages of Reits
- Volatility: Like all stocks, REITs are subject to market volatility and can experience significant price fluctuations, especially for those weaker reits. In Singapore contexts, we can see what happened to the US office reits 🙁 Conversely, real physical property prices are usually steadier.
- Interest Rate Risk: REITs may be impacted by changes in interest rates, which can affect the cost of financing for real estate loans. We can see this in the recent rate hikes.
- Potential right issues: Reits doesn’t keep much cash, hence for acquistion of new properties, repayment of debt, they may raise cash using rights issue.
Key Metrics to look out for before investing
Before investing in Reits, we should always take note of these nine metrics. Of course, these are not the full list, but one should at least know these nine metrics.
Distribution Per Unit (DPU)
Distribution per unit (DPU) is the amount of dividend paid per share. One should at least aim for 6% and above since the current risk-free treasury rate is 5%.
DPU is one of the most important metrics to evaluate when investing in REITs. It is a measure of the REIT’s ability to generate income and course the cashflow to investors. Investors should look for REITs with a history of consistent and sustainable DPU growth. If DPU keep decreasing due to Reit issue (rather than Macros situation such as COVID), investors better take note and decide if one should continue with this investment.
Growth in Distribution Per Unit
The growth in distribution per unit (DPU) is the increase in the REIT’s DPU over time. Investors should look for REITs with a consistent track record of increasing DPU. IT can be slow increase but at least must increase. One can look at the Mapletree Family of Reits such as Mapletree Logistics Trust for example.
To put in another word, a REIT that consistently grows its DPU over time indicates that it is able to generate more rental income from its properties over the years, and thus, has the potential for long-term growth. However, please take note the DPU growth should not be from the growth in debt.
Occupancy rate measures the percentage of the REIT’s properties that are currently leased. A high occupancy rate is a positive indicator of the REIT’s ability to generate rental income from its properties. Investors should look for REITs with a consistent history of high occupancy rates, as this indicates strong demand for their properties. Typically, 90% plus will be good.
Gearing measures the amount of debt that a REIT has relative to its equity. Too much debt can increase the risk of right issues and the potential defaults in the very worst scenerio. Investors should look for REITs with a manageable level of gearing, which should not exceed 40%.
Price-to-Book Ratio (P/B Ratio)
The price-to-book ratio (P/B Ratio) measures the market value of a REIT relative to its net asset value (NAV). A REIT trading at a discount to its NAV indicates that the REIT is trading at a discount to its properties.
However, low P/B values doesn’t mean the Reits in good. Conversely, usually good Reits trade above book value (example Parkway Reit). Investors should look for REITs with a P/B ratio by referencing to its historical average or those of its peers with similar assets.
Interest Coverage Ratio
The interest coverage ratio measures a REIT’s ability to pay its interest expense using its operating income. The interest coverage ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense during a given period.
A high interest coverage ratio indicates that the REIT can easily meet its interest obligations, while a low interest coverage ratio may indicate financial distress. Investors should look for REITs with a high interest coverage ratio, at least above 2.0.
Quality of Sponsors and Growth Prospects
The quality of sponsors and growth prospects are critical factors to consider when investing in REITs. The sponsors’ quality can provide investors with confidence in the REIT’s management team and its ability to generate long-term growth. Sponsors can also support potential right issues, thus price support too.
Additionally, investors should evaluate the growth prospects of the underlying properties, which can provide insight into the REIT’s potential for long-term growth. In Singapore Contacts, Capita, Ascendas, Maples and some frasers families of Reits will be great!
REITs signed agreement with Tenents for a certain agreed period. Leases will be renewed every few years. When they are a change in rental rates, this is called Rental Reversion.
Positive rental reversion means that REITs managed to get a higher rental rate from its tenants. If the rents drop, it is called negative rental reversion.
Investors should always look for REITs with positive Rental Reversion. This signal that this REITS have the bargain powering in the industries and also reflected the importance of its location and other features of the buildings. This indicates competitive advantages.
Lease Expiry Profile and Weighted Average Lease Expiry (WALE)
The lease expiry profile and the weighted average lease expiry (WALE) are metrics that provide insight into the stability and visibility of the REIT’s rental income stream. The lease expiry profile measures the percentage of the REIT’s leases that will expire in the next few years, while the WALE measures the average remaining lease term of the REIT’s portfolio.
Investors should look for REITs with a stable lease expiry profile and a long WALE. A stable lease expiry profile indicates that the REIT’s rental income stream is secure and that it has sufficient time to renew leases and find new tenants. A long WALE indicates that the REIT has a stable and predictable rental income stream, which can provide investors with a sense of comfort that the REIT’s earnings are predictable.
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