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.
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