What are REITs (Real Estate Investment Trusts)
A REIT, or real estate investment trust, is a group of properties that are bundled and packaged together under a structure that allows it to be listed on a stock exchange as a tradeable security.
The REIT earns a steady rental income from leases signed with their its tenants. REITs are mandated by guidelines as to how they should operate in order to enjoy full tax transparency (i.e. they do not have to pay corporate taxes).
One of these requirements is that a REIT needs to pay out at least 90% of its net profit as distributions to unitholders.
Another is for regular quarterly reporting that is in compliance with the rules and regulations as stipulated by the Singapore Exchange. A third requirement is that REITs’ gearing level (i.e. total borrowings divided by total assets) cannot exceed 45%.
An instrument for regular income
REITs are known for their ability to provide a regular and steady income, as most of them pay out dividends either quarterly or half-yearly. Many investors treat REITs as a bond-like instrument due to the stability and predictability of its rental income stream, and they are not wrong to perceive them as such.
Different types of REITs
There are many different categories of REITs in the market, and these are segregated according to the property segment or sub-type that they own. There are five main categories of REITs, and other more unique types may just be a subset of these five.
Other categories (such as, for example, student accommodation REITs) may eventually pop up on SGX as the REIT sector is expanding and many owners of properties may decide to package them into a REIT. But, for now, here are the five main REIT categories.
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Commercial (Office) REIT
These REITs hold commercial properties mainly used for offices, and such assets are usually located in the central business district (CBD) areas.
The supply and demand for office space will determine the rental rates that the REIT is able to charge its tenants, and a well-located commercial building in a prime location can command premium rental rates. Examples of commercial REITs include CapitaLand Commercial Trust (SGX: C61U) and Manulife US REIT (SGX: BTOU).
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Industrial REIT
Industrial REITs hold a portfolio of industrial properties, and these properties are usually located in industrial estates or business parks. The strength of the economy, as well as the over or under-supply of industrial properties in the area, will determine both the occupancy rates and rental rates for the REIT.
Examples of such REITs include Mapletree Logistics Trust (SGX: M44U), Mapletree Industrial Trust (SGX: ME8U) and Frasers Logistics & Industrial Trust (SGX: BUOU).
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Retail REIT
A retail REIT is one that owns a portfolio of retail assets. These usually comprise shopping or outlet malls, and such REITs depend on the spending power of the consumers within the region or country in order to do well.
Retail leases usually have shorter tenures and tenants tend to come and go more often compared to industrial or commercial tenants. Some examples of retail REITs include Frasers Centrepoint Trust (SGX: J69U) and Dasin Retail Trust (SGX: CEDU).
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Hospitality REIT
Hospitality refers to the tourism and leisure industry, and hospitality REITs will own assets such as hotels and serviced residences.
Such REITs rely on the strength of the local economy to draw tourists to stay in their hotels, and the room rates they are able to charge are a function of the underlying supply (of hotel rooms) and demand (for tourism). Examples of such REITs include Ascott Residence Trust (SGX: A68U) and CDL Hospitality Trust (SGX: J85).
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Healthcare REIT
The last major category of REITs is healthcare. These REITs own hospitals and medical facilities, and such REITs are considered one of the most resilient as they hinge on demand for healthcare, which tends to remain consistent throughout economic cycles. Examples of such REITs include First REIT (SGX: AW9U) and Parkway Life REIT (SGX: C2PU).
How do REITs grow?
A natural question that may arise in investors’ minds might be – how exactly do REITs grow?
There are two main methods that REITs use to grow their asset value and portfolio. One is through organic means while the other is through acquisitions. Let’s first start off with organic growth.
Organic Growth
Organic growth refers to the growth in the underlying value of the portfolio and assets within it. Assets grow more valuable if they are able to churn out a higher level and consistency of cash flows, therefore, rental rate increases (also known as “reversion rates”) are a common method for REITs to grow their portfolios organically.
Another method is to engage in what is known as “asset enhancement initiatives” or AEI. These are improvements and upgrades to existing assets in order to increase their floor area, efficiency or attractiveness, such as adding a podium to the building, refurbishing the lobby or adding on a brand new façade.
Acquisitions
Since REITs are mandated by law to pay out at least 90% of their earnings as dividends, this also means that only 10% or less is retained within the business. In order to acquire, REITs usually need to tap on two sources of funding: equity (i.e. from the stock market) or debt (from banks and financial institutions).
REITs may tap on secondary funding such as the sale of shares to institutions or the declaration of a rights issue (preferential offering) in order to raise funds quickly for deployment. If the REIT makes use of borrowings, it has to ensure that it stays within the stipulated leverage ceiling of 45% as mandated by MAS.
Important Aspects of REITs
Below is a list of important aspects for REITs that investors should take note of. It is not an exhaustive list, though, but seeks to cover the critical aspects that investors need to know in order to make an informed decision. They cover both merits (i.e. strengths) as well as risks (i.e. what could go wrong).
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Diversification
Diversification relates to both the country of exposure for the REIT as well as the number of properties it owns in its portfolio. Some REITs may have just a few assets, and this means that the REIT may rely heavily on one or two properties for the bulk of its net property income. If anything should happen to those assets, investors may witness a significant fall in their distributions.
For country diversification, look for REITs that have exposure to different countries in order to mitigate the effects of country risk. Note that this consideration should also account for foreign exchange risks as the rental income may be earned in local currency while the distribution is declared in Singapore dollars.
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Leverage
Look at the REIT’s gearing level for an indication of the amount of debt headroom it has to pursue acquisitions. If the gearing is above 40%, this severely limits the REIT’s ability to raise debt to acquire, and it may have to tap on capital markets instead.
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Cost of debt
Observe the cost of financing the REIT’s debt. If this is high or close to the REIT’s distribution yield, then there may not be much wiggle room should interest rates head up. The REIT may be forced to refinance its debt at unattractive rates or resort to tapping on capital markets to raise funds (regardless of how the unit price is performing).
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DPU growth
For REITs that have a longer listing history, investors need to study their track record for DPU growth. REITs that display a consistent track record of growing their DPU should be held in high regard by investors as the management there has literally walked the talk.
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Occupancy Rate
Occupancy rates are an important metric to track as it is an indicator of the attractiveness of the REIT’s portfolio of properties. High occupancy rates imply that tenants have committed long leases and have the financial muscle to stay on despite volatility in the economic environment.
Persistently low occupancy rates are a sign of either an unattractive asset (location or condition of the building) or weak tenants.
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Reversion Rate
Positive reversion rates are a sign of an attractive asset and high demand. It could also be a function of strong underlying economic growth. Investors need to observe this metric to assess if rental rates can be negotiated upwards, as this literally translates into higher rental income and subsequently, higher distributions per unit as well.
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Presence of sponsor
Finally, investors need to assess if the REIT has a strong sponsor. A sponsor is a parent company that helps to provide both financial support and a steady pipeline of assets for potential injection into the REIT.
The presence of a good sponsor provides assurance that the REIT can continue to grow as future asset injections are always possible, while funds also feel more confident of REITs with strong sponsors, thus improving the trading liquidity of the REIT’s shares.
