Key Factors in Selecting REITS – Part 1

Power of Organized
Knowledge

Before I start on the topic of interest Reits, have it
ever occurred to you that you might have thought you are very knowledgeable in
one subject, because you spend lots of time reading books, newspaper, magazines,
blogs etc. It is common to see that information although abundant is often
fragmented in a lengthy text.  And when
you are required to explain what you read to your families or friends, you
either have tough time recalling or information reappear in bits and pieces.

Undoubtedly, reading acquires knowledge. But knowledge
is only most efficiently absorbed when it is organize properly. Even after organization,
the knowledge must be intelligently directed through practical plans of action
to release its potential.

“Many
people thought “knowledge is power”. It is nothing of that sort!
“Knowledge is only potential power” it only becomes power once it is
organized into definite plans of action and directed to a definite end!”  – Napoleon Hill

Read an excellent article on the Business Times last
week on Real Estate Investment Trusts (Reits). It says and we know one of the most
common reasons to invest in Reits or Business Trusts is for the dividend
return. However there are many other reasons for selecting a Reits beyond its
dividend yield.

Earlier I talked about organizing knowledge. Like many
previous occasions, I will organize what I read, summarize it and reproduce in
my blogs sweetened with Rolf Suey’s flavor with
practical examples.

In this way, I hope that my reader will be able to absorb
and digest the required knowledge faster. Enough said, now let’s examine the major criteria
in picking the right Reits in your investment.





Management Team

Investor must understand management strategy,
geographic focus, execution capabilities and long term vision. Invest in high
quality and focused management with solid track records for making sound
acquisition. Management must also have ability to build a strong capital
management structure

Strong Sponsor

Strong sponsor adds credibility to the Reits. E.g. Capital Malls
& Mapletree related Reits
are backed by their parents who are
owned by Temasek Holdings – sovereign wealth fund of Singapore.

It also potentially offers pipeline of assets to
acquire. E.g. Fraser
Centrepoint Trust
recent acquisition
of Changi Point from its parent Fraser Centrepoint Ltd.

A strong sponsor track record is important for new
Reit IPO that does not have listing track records.

Quality of
Assets Portfolio

Business Exposure of Reits is important. Invest in Reits
with healthy supply and demand dynamics. Reits with sub-urban malls having good locations near train stations have healthy dynamics because no matter
how bad the economy, people still need to eat and shop near where they stay. Fraser Centrepoint Trust and Croesus Retail Trust (Japan)
are two examples.

Good specifications of location, tenant mix with diversified
range of industries also suggest less over-reliance on any single tenant/or
industry.  

Geographical diversification also reinforced earlier
point. In addition it enable growth outside Singapore scarce land, although it could
also carry additional risks especially if there is a lack of knowledge on the
overseas markets concerned. E.g. Suntec Reit had
ventured into Australia Sydney with A-Grade commercial building “177-199
Pacific Highway” acquisition end last year. The property is 100% pre-committed
by Leighton Group target completion in early 2016.

Strong balance
sheet

A) Gearing

Highly geared Reits tend to raise equity financing
(dilutive) to fund acquisitions. Lower leverage Reits provide more debt
headroom for accretive acquisitions when opportunities arise.

Reits gearing limit
is 35%. This can be
raised to 60% if the Reits obtains, discloses and maintains a
credit rating from rating agencies. Today most S-Reits gearing are well
below 40% which is still reasonably healthy.

Trusts has no cap on
borrowings and may set their own limits.
However some trusts
like 
Croesus Retail Trust has promised 100% payout for the first two years after IPO.

B) Debt Hedging

Highly geared Reits may face higher cost of financing
in a rising interest rate environment, especially those who has not hedge their
interest rate.

Better to consider Reits who refinance their expiring
loans with a longer-term debt and replacing variable rate loans with a higher
proportion of fixed rate debt. Most S-Reits have completed the bulk of their
refinancing for this year in view of the rising interest rate environment.  

Upward revaluation due to improved economic situation of Reits may also reduce gearing,
providing more headroom for debts going looking forward. Vice Versa is also
true.

C) Net Asset Value (NAV)

NAV, while not directly having bearing on unit holders’
return it gives good sense of under or over-valuation of a REIT when compare
against its price.

If NAV > Price, it represents a premium to buy
(over-value). If NAV < Price, it represents a discount to buy (under-value).
We must also note that valuation of the Reits may change over time subject to
economic factors. 
Therefore the ability of the Reits to have upside
valuation is normally more attractive. 


E.g. in China Beijing, office space is
under-supply in the next 4 years, Mapletree Greater China Commercial Reit Gateway
Plaza will stand to be benefit from this trend. With Mapletree “financial muscles” it is also unlikely that it will only own one asset in Beijing
indicating further growth possibilities.  

Since NAV do vary and it is more helpful to look for
divergence of REIT’s price from its NAV and compare it with historical average.
A Mean reversion should occur over time.

D) Stable Dividends

Ability to pay a regular and stable dividend
especially during financial crisis is an indication of a resilient company. 
For Reits, often reinvested dividends comprise the
bulk of returns, compared to capital appreciation itself. 

It is worthy to note
that Reits must distribute min. 90% of income for tax purposes, while Trusts have
no requirement to distribute, but trust may pledge to distribute a certain
percentage of income as dividends. E.g. Croesus Retail Trust
pledges 100% distribution for first 2 years after IPO last year.

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