Real Estate Investment Trust


If you love to invest in the stock market for regular incomes, for example in the form of dividend payouts, you would love Real Estate Investment Trust (REIT) as well. That way you can partake in the potential long term appreciation of properties in Singapore without forking out huge capital investments too.

What is Real Estate Investment Trust and why should you invest in this asset class? This article is a beginner introduction to REIT while we will have discussions around specific REITs listed in the Singapore Stock Exchange in the near future. These REITs are also commonly referred to as S-REITs.

Let’s explore the various aspects of REITs.

What Is REIT?

Without getting too technical, REIT is perhaps best explained with a diagram of the REIT structure:

real estate investment trust

 

A REIT is really very similar to a brick-and-mortar real estate and it is considered a company listed as a Unit Trust and transacted on the stock exchange. As an investor of a particular REIT, you are considered as a unit holder who is entitled to unit distribution (or dividends) from the REIT’s earnings. REITs make money primarily from the rental income they receive from the properties they own.

In Singapore, REITs are regulated by the Monetary Authority of Singapore (MAS) in accordance with the Code on Collective Investment Schemes, which sets out the management, operation and marketing best practices which REITs are expected to observe.

This gives rise to the REIT structure and I will now continue to explain the roles of the different REIT entities.

The Trustee is a caretaker who acts on behalf of the unit holders. The Trustee is responsible for the ownership and safe custody of the REIT’s assets (properties) and is required to ensure all property deeds are accurate and the rentals enforceable. The REIT Manager is appointed by the Trustee to manage the REIT and the responsibilities include setting strategic direction, managing assets and liabilities and recommending to the Trustee on acquisition, divestment or enhancement of assets.

The Property Manager is in turn appointed by the REIT Manager and the responsibilities will include renting out properties with best mix of tenants, collecting rents on time and carry out marketing and promotional programmes in conjunction witht the REIT Manager.

A large number of REITs in Singapore are sponsor-linked, these sponsors are usually property developers such as CapitaLand and Keppel Land. The sponsors retain a 20% to 30% stake in the REITs and collect assets management and property management fees through wholly owned subsidiaries.

As an example, let’s take a look at the REIT Capitaland Mall Trust and its structure:

real estate investment trust

How Do REITs Grow?

You invest in a REIT for the distribution (or dividend) income, but can a REIT grow? The answer is yes, and through internal expansion or through external expansion.

Internal expansion refers to growth of revenue, cutting costs or both. A REIT can grow its revenue organically by increasing rental rates or improving occupancy rate.

A REIT occasionally carries out asset enhancement initiatives (AEI) by renovating or refurbishing its existing assets, thus potentially attracting higher rental or increasing rentable area.

External expansion refers to growth through acquisition of new properties or new property development itself. This mode of growth represents a more risky growth strategy.

Types Of REITs

There are different types of REITs depending on the underlying properties they own. Of course, a REIT can also have a mix of property types.

  • Retail REITs – the underlying assets are shopping malls. Examples of retail REITs are Capitaland Mall Trust, StarHill Globl REIT and Frasers Centrepoint Trust. When investing in this type of REIT, you might want to pay attention to the tenants mix, the profile of shoppers going to the shopping malls and the occupancy rate of the malls owned.
  • Hospitality REITs – the underlying assets are hotels and service apartments. Examples of hospitality REITs are like CDL Hospitality Trust and Ascott REIT. The performance of hospitality REITs can be quite cyclical depending on economic cycles and visitor arrivals.
  • Office REITs – the underlying assets are office buildings. An example of such a REIT is CapitaCommercial Trust. If you are investing into office REITs, you want to understand the tenants in terms of which industry segments they are from, a well diversified tenant mix from various industries will be good to cushion times when particular industries are not doing well.
  • Health Care REITs – the underlying assets are hospitals, nursing homes. Examples are First REIT, Parkway Life REIT. The advantage of health care REIT is that the leases are typically longer.
  • Industrial REITs – the underlying assets are flatted factories, warehouses, industrial buildings and business parks. Examples will be Mapletree Industrial Trust and Cambridge Industrial Trust.

Some REITs are cross-border, meaning the REITs own properties in various geographical locations outside of Singapore.

Singapore REIT Regulations

There are two key regulations which we should know as REIT investors:

  • tax transparency – REITs in Singapore must give 90% of income as distribution to unit holders. When this condition is met, the REIT will not be subject to tax at the corporate level, thus providing great benefits to both the REIT and the individual investors.
  • Gearing – gearing ratio (debt over asset) must be less than 45%. A lower gearing ratio is always more desirable.

Evaluation of REITs

I have shared the stock investment framework which is a complete process of screening for stocks to invest, doing up the fundamental analysis, determining the intrinsic value, building in a margin of safety, and getting ready to buy a stock when it is undervalued.

When evaluating REITs, the same can apply but it needs to be tweaked. Fro example, out of the the various types of REITs, choose the ones you are more familiar with (your circle of competence). If you totally don’t quite understand say hospitality REITs, then avoid it.

I like how REITs prepare presentation slides quarterly which makes it easy for you to analyze their performance. A suggested MONEY framework to do the evaluation of REITs is as follows:

  • M – Management (evaluate the track record of the REIT Manager)
  • O – Owing (the gearing ratio or (total debt)/(total assets) should be preferably < 0.4)
  • N – NAV Net Asset Value (the Price/NAV or P/B ratio should be preferably < 0.8)
  • E – Estates (qualitatively analyze the locations, positionings and tenancy of assets and properties)
  • Y – Yield (> inflation rate, 5% to 7% acceptable)

I would add that you should look at the interest coverage (Net Property Income NPI/Interest Expense) is not lower than 2.5 which may spell trouble for the REIT. Monitor the distribution yield over time and ensure that it is consistent or growing over time.

Using Capitaland Mall Trust as an illustration and based on their Q1 2018 results with share price of $2.08 per unit, I would probably have:

Real estate investment trust

I also note that the interest coverage is 5.4x and that the distribution is stable over a long period of time. Overall, I am comfortable with this REIT. I would have hoped for a better yield and I don’t enjoy a margin of safety at the current price, in fact I would be paying a slight premium over the book value. Anytime CapitaMall Trust dips in price may be a time for you to take a look.

I hope this article is useful as a guide to evaluating REITs and it makes you a more intelligent investor.

References: (1) Building Wealth Through REITS by Bobby Jayaraman, (2) REITS to Riches by Tam Ging Wien and courtesy to Ivan Loh on some materials.

Disclaimer: the discussion in this article is for financial education and illustration purposes and it does not constitute any recommendation for any investment decision. Readers should exercise their own judgment and take into consideration risk factors when investing. 

A publication of Value Investing blog Journeywithmoney. Please also follow us on our Facebook Page.

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