5 Things to look out for when investing in REITs April 3, 2017

With equity indices trading higher, uncertainties on US policy such as possible tax tariff and increased tension on the Korean Peninsula, passive income assets such as Real Estate Investment Trust (REIT) have once again garnered strong interest. Comparing to last week’s closing, FTSE ST REIT Index has gain 1.32% while STI only managed to inch up 1.02%. Looking back at the past 5 years, the FTSE ST REIT Index has outperformed the STI index by 13.9%.

5 Things to look out for when investing in REITs

Source: POEMS 2.0

The recent debut of NikkoAM-StraitsTrading Asia ex Japan REIT ETF on 29 March with an opening price of $1.02 and subsequently finishing the week at $1.014, higher than its IPO price of $1.00 still shows a strong demand for this asset class till this day.

With the Federal Reserve projected to hike interest rates 2 or maybe 3 times this year, should an investor still consider investment in REITs? In my personal opinion, I believe that interest rate risks are already priced-in and the key is to cherry pick REITs with strong fundamentals.

So what are some fundamental matrix we should look at? Below is a list of my personal investment criteria that I will analyse before investing in any REIT.

Occupancy Rate and Tenant Base Occupancy Rate is the ratio of rented space as compared to available space. A comparison with past numbers would reflect how strong the REIT manager is in securing tenant. Do read these numbers together with the tenant mix to ensure that the REIT is not overly-exposed to few big tenants. A high and improving occupancy rate together with good tenant mix is always desired.
Weighted Average Lease Expiry (WALE) This defines the average lease term remaining to expire across the entire tenant portfolio and it is usually calculated as the Net Lettable Area (NLA) or Gross Rent (GR). Sometimes, a single big tenant occupying a large space for a long period may skew the WALE higher.

Higher WALE

  • Lower short term risk for any change of vacancies to the tenant portfolio -> More stable dividend per unit (DPU)

Shorter WALE

  • Able to re-negotiate rent hikes -> Possible catalyst for growth. However, this also infer possible risk of vacancy should they fail to secure new contracts.
Gearing Ratio Gearing ratio refers to the business’ level of debt compared to its equity capital. REITs in Singapore can have a leverage ratio of not more than 45%, so this will show us the health of the company and whether they would be required to raise equity to improve their balance sheet.

Higher Gearing Ratio

  • Not all debts are bad -> Debt financing might be cheaper than equity financing. However, investors should expect a higher yield for an increase in risk undertaken.

Lower Gearing Ratio

  • Lower financing risk -> Higher stability and lower risk of default.
Debt Management In an increasing interest rate environment, it is important to look out for the hedging strategy adopted by the business. This will give investors a clearer picture of the business going forward should there be any changes in interest rates. One ratio that I like to monitor is their interest coverage ratio (EBIT/Interest Expenses). This is to ensure that revenue generated is sufficient to cover their interest expenses.

Increase in interest rate will generally have negative impact on REIT prices

  • Increase in interest expenses -> Reduces Cash flow -> Reduces Distribution Per Unit (DPU)
  • Yield on government bonds rises -> Increase attractiveness -> Money outflow from REITs to other asset class
Price-to-Book (P/B) Value Investors who aren’t well-versed in valuation model such as dividend discount model, you can consider adopting relative valuation method such as P/B value. When compared with relative peers (same industry), it can tell a simply story on whether the current price is overpriced or undervalued.

Fundamental analysis is only a piece of the investing puzzle. Investors should not lose sight of the macro business outlook. For example, with possible slowing down of Singapore’s tourism, will the traffic of shopping malls in neighbourhood be more affected than those in prime district? I would say that the likelihood will be much lesser.

Last but not least, it is never wise to put all your eggs in one basket. If an investor is not able to diversify his/her portfolio due to lack of capital or prefers a more passive approach, ETF such as Phillip SGX – APAC Dividend Leaders REIT ETF or NikkoAM-StraitsTrading Asia ex Japan REIT ETF might be a better consideration in the long run.

If you wish to know more information about ETFs or any other stocks, you can speak to your designated Trading Representatives or a Dealer at a Phillip Investor Centre near you.


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About the author

Tay Tiong Yuan
Equity Dealer

Mr. Michael Tay currently provides dealing services to over 17,000 trading accounts and is part of the POEMS Dealing, the core in-house dealing department of Phillip Securities Pte Ltd.

Michael is a strong believer of value investing, focusing on companies with strong fundamentals and good dividend policy. Apart from his dealing role, he often provides training seminars on Fundamental Analysis topics to further enrich his clients’ financial knowledge.

Michael holds a Bachelor Degree of Finance from the SIM University (UniSIM) and was awarded the CFA Singapore Silver Award in 2012.

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