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Why Frasers Logistics and Industrial Unitholders Should Be Pleased With The Proposed Merger With Frasers Commercial Trust?

Frasers Logistics and Industrial Trust has proposed a move to acquire Frasers Commercial Trust. Is it good for existing unitholders?

The proposed merger of Frasers Logistics and Industrial Trust and Frasers Commercial Trust is the latest in a flurry of mergers among Singapore REITs this year. But not all mergers are good for shareholders (technically, REIT investors are called unitholders but let’s not split hairs here).

To determine if the proposition is fair to Frasers Logistics and Industrial Trust shareholders, I did a quick analysis of the deal.

[Note: An article discussing what the merger means for Frasers Commercial Trust shareholders was published on 10 December 2019. You can find it here.]

Details of the deal

In essence, Frasers Logistics and Industrial Trust will be absorbing Frasers Commercial Trust. It will pay S$0.151 in cash plus 1.233 new units of Frasers Logistics and Industrial Trust for every Frasers Commercial Trust unit.

In addition, Frasers Logistics and Industrial Trust is proposing to purchase the remaining 50% freehold interest in Farnborough Business Park that is not already owned by Frasers Commercial Trust.

Is Frasers Logistics and Industrial Trust Overpaying?

A share-plus-cash deal can be complicated to process. That’s why I prefer to break it into two parts. First is the issuance of new shares, and second is the purchase of the REIT using existing cash and the capital raised from the fundraising exercise. I will address each of these separately.

Frasers Logistics and Industrial Trust is issuing new shares at a premium to its book value. The new shares (if you consider that they are issued at market prices of $1.23), is 29% higher than Frasers Logistics and Industrial Trust’s current book value per share of S$0.95. Additionally, the new shares are being issued at a trailing annualised dividend yield of 5.8%, which is quite low for a REIT. Because of the relatively high price of the new shares issued, I think the issuance of new shares is positive for existing shareholders of Frasers Logistics and Industrial Trust.
That brings us to the second part of the assessment- the price paid for Frasers Commercial Trust. Based on the current market price of $1.23 for each Frasers Logistics and Industrial Trust share, it is paying $1.66 (1.23 x 1.23+0.151) for each Frasers Commercial Trust share. The implied price is just a 3.1% premium to Frasers Commercial Trust’s book value per share of $1.61. It is also lower than Frasers Commercial Trust’s current market price of $1.68 per share. I think this is a fair purchase price, considering the potential long-term benefits of the deal (more on this below).

Based on the above considerations, I believe the deal will benefit existing unitholders of Frasers Logistics and Industrial Trust.

Immediate impact on distribution per unit and NAV per unit

The new units are being issued at relatively high prices, and the purchase price is just a slight premium to book value. So it is not surprising that the deal is expected to have an immediate positive impact for Frasers Logistics and Industrial Trust. Management expects the acquisition to be accretive to both distribution and book value per unit.

The two charts below illustrate the pro forma accretion to book value and distribution per unit (DPU).

Source: Investor presentation for Frasers Logistics and Industrial Trust merger with Frasers Commercial Trust

Other benefits of the deal

Besides the immediate positive impact on DPU and book value per unit, there are also other potential benefits to the merger:

The enlarged REIT will likely be able to negotiate lower interest rates on its debt in the future
There are potential economies of scale due to the enlarged size of the combined REIT
The bigger portfolio will increase diversification and decrease concentration risk
The new properties absorbed by Frasers Logistics and Industrial Trust have favourable characteristics that could drive growth. For instance, 51.8% of Frasers Commercial Trust’s properties have step-up annual rent escalations of between 3.0% and 4.0%. Also, Alexandra Technopark, one of Frasers Commercial Trust’s six properties, also recently completed an asset enhancement work.

The Good investors’ conclusion

There are many reasons for existing shareholders of Frasers Logistics and Industrial Trust to like the deal. First, the deal will be immediately accretive to both book value and DPU per unit. Second, the enlarged REIT will benefit over the longer-term through economies of scale and diversification. In turn, this should provide the REIT with a longer runway for DPU-growth in the future.

Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.

REITs and The Power of Cheap Equity

REITs that have access to cheap equity are more likely to do well over the long term. Here’s why.

I’ve been studying real estate investment trusts (REITs) for some time. One thing that I noticed is that access to cheap equity is an often overlooked but powerful tool for REITs to grow.

“Cheap equity” is a REIT’s ability to raise money at a comparatively low cost.

The benefits of cheap equity

So how does cheap equity arise? First, the investing community needs to be bullish on a REIT. Usually, the REIT will exhibit some of the positive characteristics I tend to look for. The market realises the REIT’s potential and prices its units up. Such REITs end up being priced at a premium to its book value.

The high unit price of the REIT’s units creates an opportunity for it to raise money cheaply. Simply by issuing new units at this high price, the REIT is able to boost its book value per unit and its yield.

A prime example

Let’s consider a recent example. Mapletree Commercial Trust is a REIT that has been trading well above its book value for many years. In October 2019, the REIT decided to make use of its high unit price to raise cheap capital. It announced that it would raise around S$900 million to partially fund the acquisition of a property, Mapletree Business City (Phase2).

The new units were priced at S$2.24 each, well above Mapletree Commercial Trust’s book value per share of S$1.70 (as of October 2019). In addition, the REIT’s new units were issued at a low annualised yield of 4.1%.

There are two key advantages here. First, because the units were priced above book value, the equity fundraising will immediately increase the REIT’s book value per unit. Second, the funding exercise will be distribution per unit-accretive to shareholders as long as the new property purchased has an asset yield of more than 4.1% (or even less if you consider that part of the acquisition will be funded by debt).

A virtuous cycle

The ability to raise money cheapy creates a virtuous cycle for such highly regarded REITs.

Consider the case of Mapletree Commercial Trust:

Investors are bullish on Mapletree Commercial Trust’s prospects and attach a high valuation to it.
The REIT uses the opportunity afforded by its high unit price to issue new shares.
Backed by a strong sponsor, Mapletree Pte Ltd, and positive public sentiment, the REIT is able to raise new funds through an equity fundraising.
As the new units were issued at a high price, the fundraising is immediately-accretive to book value and distribution per unit.
Investors see the growth in DPU and book value per unit and become even more bullish on the REIT and the market pushes the price of the REIT higher. The REIT is now able to raise more capital cheaply.

This whole process creates a virtuous cycle that helps highly-regarded REITs keep on growing.

How investors can benefit

The lesson here is not to be put off by REITs that have relatively high unit prices. A REIT with a high unit price may not offer the best yield but it has the ability to grow much faster than its peers. Having said that, this is by no means a fool-proof scenario.

Investors will also need to pick the REITs that are best able (and willing) to make use of the opportunity afforded to the REIT through its high unit price. One of the key things to look out for is the REIT’s track record of raising equity and whether it has a sponsor with deep pockets.

The REITs that are sponsored by CapitaLand, Mapletree and Frasers have, historically, been some of the best REITs in Singapore’s stock market to own. These three sponsors have been willing to support their REITs through capital injections, even at high valuations.

Knowing this, shrewd investors who spot this trend can capitalise and ride the virtuous upcycle driving well-regarded REITs.

Why I Invested in Sasseur REIT

Sasseur REIT has been one of the top-performing REITs so far this year. Here is my thought process behind my decision to invest in it in March this year.

Sasseur REIT has been one of the top-performing Singapore-listed REITs this year, with a year-to-date return of more than 40%.

I invested in Sasseur REIT in March this year at a purchase price of 72 cents per share. Today, the stock trades at around 88 cents. In addition to the capital gain, I have also collected 4.9 Singapore cents in dividend (technically called a distribution but let’s not get nit-picky).

In this article, I will explain my investment thesis for Sasseur REIT and whether I think it is still worth a look at today.

Company description

Sasseur REIT owns four outlet malls in China. The REIT is sponsored by Sasseur Group, a privately-owned outlet mall operator that currently manages and operates nine outlet malls.

The China-based REIT was listed in Singapore on 28 March 2018. Since listing, Sasseur REIT has performed well above expectations. It beat its initial public offering forecast for seven consecutive quarters, both in terms of rental income and distribution to unitholders.

My 5-point framework

Over the years, I have built a five-point framework for investing in REITs. I try to invest in REITs that tick as many of the boxes as possible.

As a quick summary, the REITs I invest in should have (1) a good existing portfolio, (2) capable and honest management, (3) a safe capital structure, (4) a fair and responsible sponsor and (5) a decent valuation.

I will describe my investment thesis for Sasseur REIT using this REIT framework.

1. A good existing portfolio

In my view, Sasseur REIT has an excellent existing portfolio.

To understand the REIT’s portfolio better, we need to appreciate its unique mode of managing the four malls it owns. The REIT effectively outsources the management of the mall to a third party called the entrusted manager.

Favourable entrusted manager agreement

The entrusted manager is responsible for maximising the rental income of the assets. It collects the rent and pays Sasseur REIT an entrusted manager agreement rental income.

This comprises a fixed and a variable component.

There are a few things to like about this arrangement. First, the fixed component ensures a baseline level of rental income that is more or less guaranteed every year. The fixed component will also rise each year.

Second, the variable component gives Sasseur REIT the opportunity to participate in the upside, should tenant sales rise.

Increasing tenant sales

There are a few reasons to believe that tenant sales will increase in the long run. For one, total VIP members (a membership program to reward high-spending customers) have jumped a staggering 70% from the end of 2018 to 30 September 2019. Second, two of the REIT’s malls are still relatively new and should attract more shoppers as they mature.

There are also macro-economic tailwinds. China’s GDP is expected to grow by more than 6% in 2019 and 2020. The GDP growth, in turn, is expected to fuel a rise in the middle-income population in China, which will drive demand for discounted branded goods.

Sasseur REIT’s four malls demonstrated impressive growth in 2019. In total, the four malls generated a 20.9% growth in tenant sales in the first three quarters of 2019.

Positive portfolio characteristics

The occupancy rate at Sasseur REIT’s malls is also very high, averaging at 95.4%. This is a sign that the REIT is able to attract tenants to its malls.

The REIT has deliberately short tenant leases, which give the managers more flexibility to improve the tenant mix and to increase rent in the future.

Potential downsides

There are, however, two downsides to Sasseur REIT’s existing portfolio. First, its four malls are leasehold. The tenures range from 27 to 35 years. Second, the REIT owns only four malls so there is an element of concentration risk. Nevertheless, I think its current portfolio still possesses more pros than cons.

2. A capable and honest management

Sasseur REIT has a relatively short track record as a listed REIT. Despite its short history, I think the way the managers are incentivised gives me confidence that they have minority shareholders at heart.

First, the entrusted manager has shown a good track record of growing the portfolio’s tenant sales. In addition, resultant rent, and consequently distribution per unit, have beaten expectations each and every quarter since the REIT’s listing. I am more inclined to trust managers that underpromise and overdeliver.

Additionally, both the REIT manager and the entrusted manager have incentives that are aligned with shareholders’ interest.

The entrusted manager is paid a base fee that is calculated as the lower of (1) 30% of gross revenue or (2) gross revenue minus EMA Resultant rent (what is paid to Sasseur REIT).

In essence, the entrusted manager is entitled to the leftover of gross revenue after paying what it owes to Sasseur REIT. However, this amount is capped at 30% of gross revenue. If there is left-over after the base fee and EMA resultant rent is paid to Sasseur REIT, the entrusted manager is then entitled to 60% of the leftover amount as a performance bonus.

From the way the entrusted manager is incentivised, it is clear that it is in the entrusted manager’s interest to try to grow gross revenue for the REIT, which is ultimately also beneficial to the REIT unitholders.

The REIT managers also have a base fee and a performance fee. The REIT managers are only entitled to the performance fee if it achieves distribution per unit (DPU) growth over the previous financial year.

3. A safe capital structure that can be optimised

Sasseur REIT has a gearing ratio of 29.0%, well below the regulatory ceiling of 45%. This gives it the debt headroom to take more loans to invest in new properties.

The REIT’s cost of debt is also manageable at 4.43% (reasonable by China standards). The relatively low interest rates give it an interest coverage of 4.8 times.

I also take heart in the fact that the manager has emphasised that they are going to be using the REIT’s financial muscle prudently. The manager will only look at yield-accretive acquisitions that can benefit unitholders over the long-term.

4. A fair and responsible sponsor

As a first-time REIT sponsor, investors don’t have much information to judge Sasseur Limited.

However, the sponsor has not interfered much in the way that Sasseur REIT has been run. It has not shown that it will treat minority shareholders unfairly.

On top of that, the sponsor also has a lineup of right-of-first-refusal properties in its portfolio that Sasseur REIT can tap on for future acquisitions.

As one of the largest outlet mall operators in China, it also boasts the experience and know-how that Sasseur REIT can use as it seeks to expand its portfolio in the future.

Based on and despite the limited information I have, I am fairly satisfied with the sponsor.

5. A decent valuation

Valuation is the final aspect to consider. Sasseur REIT has seen its share price soar over the past 12 months. It currently sports an annualised distribution yield of 7.4%.

When I bought it earlier this year, the REIT had a yield of 9.8%. Based on the lower yield today, the REIT seems expensive now.

But investors should note that at the time of writing, REITs in Singapore have an average yield of around 6%. This makes Sasseur REIT’s current 7.4% yield look comparatively cheap. As such, it may be that Sasseur REIT was trading at an unfairly low valuation earlier this year, rather than an overly rich price today.

The Good Investors’ Conclusion

Despite the recent run-up in price, Sasseur REIT still looks like an attractive stock to hold. The REIT ticks many of the right boxes and seems primed to continue increasing its distribution per unit.

There are risks to note. The REIT has high concentration risk, currency risk and is highly dependent on economic tailwinds. But despite these risks, I think the REIT’s positive traits and growth potential still give me an excellent risk-reward profile.

REITs With Overseas Properties: Yay or Nay?

Mapletree North Asia Commercial Trust and Eagle Hospitality Trust, two REITs that are listed in Singapore with overseas assets, have been in the news for all the wrong reasons.

If you are not familiar, Festival Walk, one of Mapletree North Asia Commercial Trust’s key assets in Hong Kong, was vandalised by protesters earlier this week. Meanwhile Eagle Hospitality Trust is at risk of losing one of its key assets, The Queen Mary, due to actions from its sponsor.

Both REITs have seen their unit prices fall considerably when the respective news broke.

The predicament that the two REITs are in has shone some light on the risks involved with investing in REITs with overseas properties. As such, I thought it is an opportune time to discuss some of the advantages and risks of investing in this asset sub-class.

The Positives

Let’s start with the main reasons why investors may want to invest in these REITs.

Diversification

The most important advantage is REITs with overseas portfolios give investors the chance to gain exposure to a different geographical market. This gives investors the opportunity to participate in economies that could be faster-growing than Singapore’s. It also helps to diversify your portfolio away from Singapore.

Higher yields

REITs with overseas portfolios tend to trade at a discount to REITs with predominantly local portfolios. It is common to find that REITs with overseas properties have much higher yields, offering the potential for better returns.

The downside

While there is the possibility of higher returns, investors also need to be familiar with the downsides and risks.

Withholding taxes

Certain countries have a withholding tax law. This means that cash sent back to shareholders in Singapore end up being taxed, which reduces the REIT’s distributable income.

EC World REIT, for instance, has had to pay a withholding tax to authorities when they repatriated income to Singapore.

Currency fluctuations

If you want to receive your distribution in Singapore dollars, you may have to contend with currency fluctuations. REITs with overseas properties tend to collect rent in the local currency. As such, if the currency depreciates against the Singapore dollar, you may be left with a lower distribution.

Ascendas India Trust is a good example. The steep depreciation of the Indian Rupee has had a big impact on the REIT’s Singapore-dollar-denominated distributions.

Political environment

Singapore enjoys a relatively stable political climate. We tend to take the peace of our country for granted. However, this may not be the case for other countries.

Right now, Hong Kong is facing a major political crisis with protests stretching for more than six months.

As mentioned, earlier this week, Mapletree North Asia Commercial Trust saw its share price stumble after protestors vandalised Festival Walk and set fire to the Christmas tree in the mall. As Festival Walk contributed more than 60% of the REIT’s revenue in 2018, the REIT’s rental income could drop.

Difficulty assessing the quality of the properties

It is easy to visit a shopping mall in Singapore to assess the crowd and the tenants. However, assessing the quality of overseas properties is much more challenging.

Investors who are unwilling to go down to physically examine a REIT’s portfolio will have to rely on annual reports and the details of the property in the company’s quarterly filings.

REITs with overseas properties: Yay?

Knowing both the pros and risks, the question now is whether it is still worth investing in REITs with overseas portfolios?

I think the answer is yes!

Despite the recent mishap at Mapletree North Asia Commercial Trust and Eagle Hospitality Trust, the potential for a higher return is too good to ignore. The market is currently very apprehensive of such REITs and has generally priced them at a large discount to their peers. The price mismatch has created an opportunity for more yield-hungry investors.

Don’t let the two recent sagas deter you. I believe many REITs with overseas properties, despite the risks, are likely to continue dishing out stable dividends and will continue to provide investors with great long-term returns.

We can also reduce risk by choosing the REITs within this sub-class that have more favourable characteristics. If we do our research and diversify sufficiently, I think it is still a good idea to have REITs with overseas properties in your investment portfolio.

“Should I Buy Mapletree North Asia Commercial Trust Now?”

Investors are fearful of Mapletree North Asia Commercial Trust right now. Should we buy its shares? The answer is surprisingly complicated.

Yesterday, a wise and kind lady whom Jeremy and I know asked us: “Buying when there is blood on the street is a golden rule in investing. So should I buy Mapletree North Asia Commercial Trust now?”

I responded to her query, and I thought my answer is worth sharing with a wider audience. But first, we need a brief introduction of the stock in question.

The background

Mapletree North Asia Commercial Trust is a REIT (real estate investment trust) that is listed in Singapore’s stock market. It currently has a S$7.7 billion portfolio that holds nine properties across Beijing, Shanghai, Hong Kong, and Japan.

Festival Walk is a retail mall and is the REIT’s only property in Hong Kong. It also happens to be Mapletree North Asia Commercial Trust’s most important property. In the first half of FY19/20 (the fiscal year ending 31 March 2020), Festival Walk accounted for 62% of the REIT’s total net property income.

Hong Kong has been plagued by political and social unrest for months. On 12 November 2019, protestors in the special administrative region caused extensive damage to Festival Walk. Mapletree North Asia Commercial Trust’s share price (technically a unit price, but let’s not split hairs here!) promptly fell 4.9% to S$1.16 the day after. At S$1.16, the REIT’s share price had fallen by nearly 20% from this year’s peak of S$1.43 (after adjusting for dividends) that was reached in July.

For context on Mapletree North Asia Commercial Trust’s sliding share price over the past few months, consider two things.

First, the other REITs under the Mapletree umbrella have seen their share prices rise since Mapletree North Asia Commercial Trust’s share price peaked in July this year – the share prices of Mapletree Industrial Trust, Mapletree Logistics Trust, and Mapletree Commercial Trust have risen by 13%, 5%, and 12%, respectively (all after adjusting for dividends). Second, Mapletree North Asia Commercial Trust’s results for the second quarter of FY19/20 was released on 25 October 2019 and it was decent. Net property income was up 1.3% from a year ago while distribution per unit inched up by 0.6%. And yet, the share price has been falling.

To me, it seems obvious that fears over the unrest in Hong Kong have affected investors’ sentiment towards the REIT.

The response

My answer to the lady’s question is given in whole below (it’s lightly edited for readability, since the original message was sent as a text):

“Buying decisions should always be made in the context of a portfolio. Will a portfolio that already has 50% of its capital invested in stocks that are directly linked to Hong Kong’s economy (not just stocks listed in Hong Kong) need Mapletree North Asia Commercial Trust? I’m not sure. But in a portfolio that has very light exposure to Hong Kong, the picture changes.

Mapletree, as a group, has run all its REITs really well. But most of the public-listed REITs are well-diversified in terms of property-count or geography, or both. Mapletree North Asia Commercial Trust at its listing, and even today, is quite different – it’s very concentrated in geography and property-count. But still, the properties seem to be of high quality, so that’s good.

Buying when there’s blood on the streets makes a lot of sense. But statistics also show that of all stocks ever listed in the US from 1980 to 2014, 40% have fallen by at least 70% from their peak and never recovered. So buying when there’s blood on the streets needs a caveat: That the stock itself is not overvalued, and that the business itself still has a bright future.

Mapletree North Asia Commercial Trust’s valuation looks good, but its future will have to depend on the stability of Hong Kong 5-10 years from now. I’m optimistic about the situation in Hong Kong while recognising the short-term pain. At the same time, I won’t claim to be an expert in international relations or the socio-economic fabric of Hong Kong. So, diversification at the portfolio level will be important.

With all this being said, I think Mapletree North Asia Commercial Trust is interesting with a 2% to 3% weighting in a portfolio that does not already have a high concentration (say 20%?) of companies that do business in Hong Kong.”

Perspectives

I mentioned earlier that Mapletree North Asia Commercial Trust’s valuation looks good and that it owns high-quality properties.

The chart below shows the REIT’s dividend yield and price-to-book (PB) ratio over the last five years. Right now, the PB ratio is near a five-year low, while the dividend yield – which is nearly 7% – looks favourable compared to history.

On the quality of the REIT’s property portfolio, there are two key points to make: First, the portfolio has commanded a high occupancy rate of not less than 98.5% in each of the last six fiscal years; second, the properties in the portfolio have achieved healthy rental reversion rates over the same period.

*Source: Mapletree North Asia Commercial Trust earnings presentation*

Mapletree North Asia Commercial Trust also scores well at some of the other traits that could point us to good REITs:

Growth in gross revenue, net property income, and distribution per unit – The REIT’s net property income has grown in each year from FY14/15 to FY18/19, and has increased by 9.4% per year. Distribution per unit also climbed in each year for the same period, and was up by 4.1% annually.
Low leverage and a strong ability to service interest payments on debt – The REIT has a high leverage ratio. As of 30 September 2019, the leverage ratio is 37.1%, which is only a small distance from the regulatory leverage ratio ceiling of 45%. But its interest cover ratio for the quarter ended 30 September 2019 is 4.2, which is fairly safe.
Favourable lease structures and/or a long track record of growing rent on a per-area basis – At the end of FY18/19, nearly all of Festival Walk’s leases included step-up clauses in base rent. Small portions of the respective leases for the other properties in the REIT’s portfolio also contain step-up clauses. In addition, the REIT has been able to produce strong rental reversions over a multi-year period, as mentioned earlier.

Conclusion

Mapletree North Asia Commercial Trust currently has an attractive valuation in relation to history. It’s also cheaper than many other REITs in Singapore – for example, its sister REITs under the Mapletree group have dividend yields ranging from only 4% to 5%. It also has other attractive traits, such as a strong history of growth, a safe interest cover ratio, and favourable lease structures.

On the other hand, Mapletree North Asia Commercial Trust has high concentration risk since Festival Walk accounts for more than half its revenue. Moreover, Festival Walk’s prospects depend heavily on the stability of Hong Kong’s sociopolitical fabric. I don’t think anyone can be certain about Hong Kong’s future given the current unrest (which seems to have escalated in recent weeks). These increase the risk profile for the REIT in my view.

To balance both sides of the equation on Mapletree North Asia Commercial Trust, I think my point on portfolio-level diversification given in my answer to the lady’s question is critical.

I’m often asked if a certain stock is a good or bad buy. The question is deceptively difficult to answer because it depends on your risk appetite and your investment portfolio’s composition. A stock that makes sense for one portfolio may not make sense for another. Keep this in mind when you’re assessing whether Mapletree North Asia Commercial Trust is suitable for your portfolio.

5 Things To Look For in REITs

Here are 5 essential characteristics you want your REITs to have.

Investing in Real Estate Investment Trusts (REITs) can be hugely rewarding. Besides providing investors with exposure to a variety of real estate, REITs also enjoy tax benefits and pay out regular and stable dividends (technically REIT dividends are called distributions but let’s not split hairs here) each year.

But as with any asset class, not all REITs will perform equally. Investors need to be able to sieve the wheat from the chaff. With that said, here are five things to look out for that can help you choose the best REITs to invest in.

1. A strong existing portfolio

Investors should look for a REIT that has a good line-up of properties in its portfolio. As a guide, here are some qualities to look out for:

A diversified portfolio of properties, which ideally includes both Singapore and off-shore assets
Properties that have a long or free-hold land lease
Highly sought after sites that could appreciate in value over time
Properties that are located near to public transport or residential hubs (in the case for retail REITs)
Characteristics that suggests tenants are willing to continue renting the space such as a high tenant retention rate, history of positive rental reversions and a high occupancy rate

2. Capable and honest management

Managing a portfolio of properties is no easy task. Managers of the REIT need to maintain a good working relationship with tenants, upkeep the property and carry out strategic asset enhancements to keep the property desirable.

On top of that, managers also have to sell underperforming assets and recycle the proceeds into investments that can grow over time. REIT managers need to make use of low-interest rate environments to grow the portfolio, whilst maintaining a safe capital structure.

With that said, here are some qualities to look for:

A long track record of stable returns for unitholders
A track record of good capital-allocation decisions
A low frequency of private placement (sale of equity only to privileged investors) equity fundraising that dilutes minority unitholders

3. A safe capital structure that can be optimised further

Ideally, investors should look for REITs that still have room to grow in the future. One way that a REIT can grow is to take on more debt in the future to buy assets that can increase its dividend per unit.

In Singapore, REITs need to maintain a capital structure that has not more than 45% debt and 55% equity. Investors should look for REITs that have debt levels well below this regulatory ceiling. While there is no hard and fast rule here, I prefer REITs that have a debt-to-asset ratio of not more than 35%.

The interest expense should also be manageable. REITs will usually provide investors with a snapshot of how much interest they have to pay relative to their earnings. This is called the interest coverage ratio. The higher the interest coverage ratio the better as it suggests the REIT earns more than enough to cover interest payments.

4. A good an honest sponsor

The REIT sponsor is usually also one of its major shareholders. It is responsible for providing the REIT with a pipeline of properties and may also have a stake in the REIT managers.

With such a big say in how the REIT is run and the possibilities of conflict of interest, it is therefore absolutely vital that you trust that the sponsor will treat minority shareholders responsibly.

To determine if a REIT has a good sponsor, investors need to look at the sponsor’s track record in both sponsoring and managing REITs.

Mapletree Investments Pte Ltd in Singapore is one example of a good sponsor that has treated minority shareholders responsibly in the past.

5. A decent valuation

Last but certainly not least is a decent valuation. While some investors prescribe the use of the price-to-book ratio to determine value, I prefer the dividend yield. REITs are a buy-and-hold vehicle and usually do not rapidly recycle their assets. As such, REITs may trade below or above their book values for extended periods of time. For instance, REITs that own properties located in Hong Kong tend to trade at a discount to book value because of the relatively low rental yield of properties in Hong Kong.

On the other hand, the distribution yield gives investors a much clearer idea of how much returns they can actually expect to make.

An investment return in a REIT is the addition of the current yield plus any capital appreciation. As such, investors should look for REITs that have high yields rather than low book values.

The Final Takeaway

Of course, REITs that displays the first four characteristics listed above will likely not sport the highest yields in the market. Investors need to determine for themselves what’s a good price to pay for a REIT that exhibits these favourable characteristics. From experience, if a REIT fits all the characteristics above but trades at a slight premium to the market (ie lower distribution yields compared to the other REITs), they still tend to do much better than their peers over time.

How To Pick REITs That Can Feed You For Life

Here are a few tricks on how to pick the best REITs for your portfolio.

Real estate investment trusts (REITs) are often seen as a reliable source of income for investors.

But that does not mean that you should simply go buy the REIT with the highest yield.

There is a problem with choosing REITs purely based on how cheap they are. That’s because a cheap REIT may be facing problems that could lead to them producing much lower dividends in the future.

Cheap for a reason

For example, let’s assume you bought Sabana Shariah Compliant REIT five years ago.

Back then, Sabana Shariah REIT had a dividend yield of around 7.5% and was paying out a dividend of S$0.0774 per share. By all accounts, that is a handsome yield to have.

ButHowever, today, Sabana Shariah REIT’s dividend is just S$0.0286 per share. Your dividend yield, based on the price you initially paid for the REIT and the dividend today, would be just 2.8%.

Now, let’s assume you had bought Mapletree Commercial Trust five years ago instead, at a dividend yield of 5.5%. That’s lower than what Sabana Shariah REIT offered.

Mapletree Commercial Trust’s dividend five years ago was also S$0.0774 per share. But today, its dividend has grown to S$0.0927 per share. Your dividend yield, based on the price you initially paid for Mapletree Commercial Trust and the dividend today, would be 6.6%.

REITs that Can Feed You For Life

When choosing REITs to invest in, never look at just how high their dividend yields cheap they are. There are many other factors to consider.

As background, I helped to develop the investment framework for a prior Singapore-REIT-focused investment newsletter with The Motley Fool Singapore during my tenure with the company.

The newsletter has delivered good investment returns, so I thought I can offer some useful food-for-thought here. The REIT newsletter was launched in March 2018 and offered 8 REIT recommendations.

As of 15 October 2019, the 8 REITs’ have generated an average return (including dividends) since the newsletter’s inception of 28.8%. In comparison, the Straits Times Index’s return (including dividends) was -3.1% over the same time period. The average return (including dividends) as of 15 October 2019 for all other Singapore-listed REITs that I have data on today that was also listed back in March 2018 is 17.52%.

The investment framework we used had four key pillars.

First, we looked out for long track records of growth in gross revenue (essentially rent the REITs collect from their properties), net property income (what’s left from the REITs’ rent after paying expenses related to the upkeep of their properties), and distribution per unit.

A REIT may fuel its growth by issuing new units as currency for property acquisitions and dilute existing unitholders’ stakes. As a result, a REIT may show growth in gross revenue, net property income, and distributable income, but then have a stagnant or declining distribution per unit. We did not want that.

Second, we looked out for REITs with favourable lease structures that feature annual rental growth, or REITs that have demonstrated a long history of increasing their rent on a per-area basis. The purpose of this pillar is to find REITs that have a higher chance of being able to enjoy organic revenue growth.

Third, we looked for REITs with strong finances. In particular, we focused on the gearing ratio (defined as debt divided by assets) and the interest coverage ratio (a measure of a REIT’s ability to meet the interest payments on its debt).

We wanted a low gearing ratio and a high-interest coverage ratio. A low gearing ratio gives a REIT two advantages: (a) the REIT is likelier to last through tough times; and (b) the REIT has room to take on more debt to make property acquisitions for growth.

A REIT with a high-interest coverage ratio means that it can meet the interest payment on its borrowings without difficulty. At the time of the REIT newsletter’s launch, the eight recommended-REITs had an average gearing ratio of 33.7%, which is far below the regulatory gearing ceiling of 45%. The eight recommended-REITs also had an average interest coverage ratio of 6.2 back then.

Fourth, we wanted clear growth prospects to be present. These prospects could be in the form of newly-acquired properties with attractive characteristics or properties that are undergoing redevelopment that have the potential to deliver higher rental income in the future.

Get Smart: REITs Assemble!

It’s important to note that there are more nuances that go into selecting REITs and that not every REIT that can ace the four pillars above will turn out to be winners. In fact, one of the eight recommended REITs actually generated a loss of 17% from the newsletter’s launch to 15 October 2019. The experience of the REIT newsletter shows just how crucial diversification is when it comes to investing, not just in REITs, but in the stock market in general. But at the very least, I hope what I’ve shared can be useful in your quest to invest smartly in REITs.

To sum up, keep an eye on a few factors:

Growth in gross revenue, net property income, and crucially, distribution per unit.
Low leverage and a strong ability to service interest payments on debt.
Favourable lease structures and/or a long track record of growing rent on a per-area basis.
Catalysts for future growth.
Don’t forget to diversify!

Note: An earlier version of this article was published at The Smart Investor, an investing website run by my friends.