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Here are the 7 things you should take note of when investing in REITs.
- Potential of DPU growth
- The growth potential of Dividend per Unit (DPU) depends on both internal and external factor.
- Internal factor relies on increase in occupancy rate, rental reversion rate and capital growth of properties value. This can be done via renovation and refitting, marketing campaign to increase foot traffic and efficient cost control by management.
- External factors relies on management expertise on cost of financing, accessibility to easy credit, management capability on developing or securing new properties and the right time to dispose an property to unlock shareholder value.
- Asset Quality
- Location is the outmost important criteria when you are selecting a REITs.
- Is it located at a first tier city or a second tier?
- Is it located in Central Business District (CBD) or suburb?
- Is it a Grade A/B/C office? Grade A office are well located, good accessibility and professionally managed. They attract the highest quality tenant and command the highest rent. Grade B are older but still have good quality management and tenants. Grade B buildings can return to Grade A through renovations. Grade C office are old buildings located in less desirable areas and often need extensive renovation. Their building infrastructure and technology are outdated and architecturally least desirable. However, Grade C building are often targeted as re-development opportunity.
- Are the properties meets the current demand and business cycle? Demand and supply is the most important factor that contribute to rental reversion.
- Management and future expansion plan
- Listing a company comes with a cost but provides an alternative way for company to access to credit. If the management has no expansion plan in mind, listing the REIT may only be a way for the previous building owner to discard their non prime property
- Singapore has allowed a ceiling for development assets of 25% of the REITs value. Malaysia may soon be allowed to put 15% of total assets into development projects and vacant land for development. With rules relaxing, a REIT with strong future expansion plan and competent management will surely add more value to the REIT. (has a 45% cap on leverage limit for REITs)
- Regardless of a company quality or growth prospect, valuation is an important factor that decide whether you could make money from this investment. Prime location property are the darling of every REITs investors. However, investors should be aware that when price is rising so much faster than the potential earning rise, your risk are enlarged as well.
- When a REIT focus on a certain type of property or holding only a few properties, its rental income may be over-concentrated. Investors should diversify the risk yourself by holding several REITs that exposed to different property market.
- Debt Level
- Debt level could be an important level when market fluctuation heightened. High debt level REITs could face difficulties on refinancing as their property value drops.
- REITs with low debt level could get credit more easily when opportunity emerge during market plunge.
- Malaysia has a 45% cap on leverage limit for REITs (http://www.theedgeproperty.com.my/content/786830/m-reits-may-be-allowed-build-own-properties)
- Singapore has a 45% cap on leverage limit for REITs (https://www.nracapital.com/research/rpt1507453266/mas-announces-new-guidelines-for-the-singapore-reit-sector)
- However, REITs that are hoarding too much cash or not utilizing any debt is definitely a bad REITs as the management are not using all their available resources efficiently.
- Interest Rate
- Do note that interest rate hike would increase finance cost of REITs. The yield premium between Government Bond and REITs will also be squeezed causing investors to ditch REITs and go for bond. This causes REITs price to drop.
- However, interest rise when economy is heatening up which provide opportunity for rental hike
- Financial Engineering
- Income support may be given to jack up the yield. This occurs when a developer builds a property and sells it to their REIT. To ensure the shareholders of the REIT approve the purchase of the property, income support is ensure to make the acquisition of property lucrative. However, the purchase price is usually much higher than the market price
- Management using a lot of Interest Rate Swap to reduce current financing cost. This may be a financial make up that the management use to boast current bottom line ignoring future risk.
- As most management charge a percentage of total asset under management as their management fee, some management might introduce Dividend Reinvestment Plan (DRP) when there is no plans to expand or no desire need to conserve cash. This is only a tactic management hope to get a bigger share of management fee by exploiting the shareholders.
- P/E may not be useful for REITs. Earnings may be misleading as property revaluation are gain are not cash item
In short, rental income is always more stable and less volatile than sales or earnings. REITs is undeniable an effective way to participate in the market and suitable for investors who wants to invest risk free. *