Guide to Analysing REITs in Singapore

This article originated from my blog: Frugal Youth Invests

I got to know of REITs about 2 years ago. New to REITs and eager to earn passive income, I began to research on how to analyse REITs. I posted my first REIT analysis on InvestingNote which garnered much attention from the community and this inspired me to start on my own investing blog.

If you are a regular reader of Frugal Youth Invests, you would know that my posts are mainly analysing REITs. I enjoyed analysing REITs but in this post, I will share about the qualitative and quantitative factors that I consider when picking the best REITs to invest in Singapore.

Qualitiative Factors

1. Sponsor

Majority of the REITs in Singapore have sponsors that are property developers like Mapletree, Ascendas, Frasers, CapitaLand and Lendlease. Having a sponsor that is a large property developer like the ones mentioned above gives comfort to unitholders that there is a visible pipeline of assets that could be acquired in the future. REITs have ample room to grow inorganically, in turn grow its DPU, through acquisition of properties being recycled from its sponsor.

For instance, Capitaland Retail China Trust recently expanded its mandate to include sectors such as include and industrial assets, including business parks, logistics facilities, data centres and integrated developments. With this expanded mandate, DBS Research estimates that CRCT can tap into more than $33 billion worth of pipeline from its sponsor CapitaLand, which is 10 times the current AUM of CRCT.

2. Management

Management should act in the best interest of the unitholders instead of enriching themselves through the management fee structure of the REIT. Management fee structure usually consists of Base Fee and Performance Fee. Base Fee for management is usually based on a certain percentage on the AUM of the REITs. Performance Fee is usually based on a certain percentage on the Net Property Income while there are some REITs which peg its Performance Fee based on DPU Growth Model where management will only receive performance fee if there is an increase in DPU compared to previous FY.

Some unitholders argue that REITs not practising DPU Growth Model is allowing the management to enrich itself and not aligning the interest of the unitholders in growing DPU. This is because with Performance Fee peg to Net Property Income, management can just acquire more properties that are dilutive to the unitholders and still receive more performance fee in the end.

I agree that with the DPU Growth Model, the manager will be more committed to growing its DPU, which in turn benefits the unitholders. At the end of the day, it is about how effective the management is to grow its DPU without having motivators such as DPU Growth Model. For instance, Mapletree Industrial Trust has had an uninterrupted DPU growth over the years yet its Performance Fee is based on Net Property Income, whereas ESR Reit has not been growing its DPU much despite using the DPU Growth Model.

We can also judge the management of the REITs in times of crisis. Prior to multiple acquisitions by Mapletree North Asia Commercial Trust, MNACT’s Festival Walk contributed 62% of Gross Revenue. The property took a hit when Hong Kong started protesting for democracy as its property were badly damaged by the protestors - affecting rental revenue for the REIT. The management took swift actions with the support from its sponsor Mapletree Investment to acquire properties to accelerate the income diversification of the REIT and reduce asset and income concentration of Festival Walk. For one of its acquisitions, management waived its acquisition fee (which would have been 0.75% of the property value) to demonstrate its support. With multiple acquisitions after the protest in Festival Walk, management managed to reduce Festival Walk’s contribution to Gross Revenue from 62% to 45%.

To add on, MNACT’s management demonstrates its best ability to align its interest with unitholders by waiving the entitlement of performance fees due to the impact of COVID and “low-base” effect. Management has decided to waive its entitlement to any performance fee until DPU exceeds 7.124 cents (achieved in FY19/20).

Quantitative Factors

1. Distribution History

An investor’s returns from an investment consists of dividend and capital appreciation. The main reason investors invest in REITs is because it offers higher dividend yield compared to other stocks available. It is of course a no brainer to invest in a REIT that constantly grows its distribution over year compared to REITs that have stagnant or declining distribution.

I believe that having a track record of growing DPU over the years gives investors confidence in investing in the REITs and the management running it. One example of a REIT with growing DPU is Mapletree Industrial Reit. Its DPU grew from 8.41c in 2012 to 12.24c in 2020, an increase of about 45% in 8 years, while increasing its AUM from $2.7b to $5.9b during the same period.

REITs with growing distribution as a track record are usually traded at a premium, thus having lower distribution yield than a REITs with stagnant or declining distribution. Mapletree Industrial Reit's distribution yield stands at 4.24% (based on FY19/20 distribution). On the other hand, ESR Reit's is yielding 10% (based on FY19/20 distribution).

2. Occupancy Rate

It is important to look at the occupancy rate before investing in a REIT. This is because the main business of a REIT is to lease out its floor space to potential tenants and in return receive rental income as revenue. This rental income becomes distribution for unitholders after deducting necessary expenses such as property operating expenses, finance expenses and other expenses.

A high and stable occupancy rate is recommended when deciding on which REIT to invest in. It shows that the property owned by the REIT is attractive in the eyes of the tenants. It also shows the competency of the management in looking for tenants and closing the lease deals with them. Although having 100% occupancy rate is great, this means that the management will not be able to capture higher rental from new tenants due to favourable market conditions.

3. Lease Expiry, WALE and Rental Reversion

Aside from looking at the Occupancy Rate of the REIT, investors should also be looking at Lease Expiry, Weighted Average Lease Expiry and Rental Reversion.

For lease expiry, we would like to see that the lease is evenly distributed with little to no concentration in lease expiring in a particular year. With an evenly distributed lease expiry, investors will not be alarmed if the management is not able to renew all its expiring lease, since distribution income will not be affected significantly.

WALE or Weighted Average Lease Expiry is defined as the weighted average lease term remaining to expire across a portfolio, it can be weighted by rental income or leasable area. In times of certainty, having a higher WALE is preferred as management does not need to find tenants thus providing stability in rental income. However, with longer WALE, the REIT will miss out on the opportunity of rising market rental rates unless there is rental review in the lease.

As investors, we do not only look at whether the management has successfully renewed its expiring leases, we also look at the Rental Reversion, which is key to growth in distributable income organically. According to SPH Reit, its Rental Reversion calculation is computed based on a weighted average of all expiring leases. The change is measured between average rents of the renewed and new lease terms and the average rents of the preceding lease terms. With that, we like to see positive rental reversion for renewed lease.

4. Concentration in Tenants

Do not put all your eggs in one basket. This idiom is used when we are researching how much their top 10 tenants are contributing to the REIT’s rental income. The key to reducing top 10 tenants’ rental contribution is to have a diversified tenant base.

For example, Ascendas Reit has more than 1450 tenants with top 10 tenants only contributing 17.7% of monthly portfolio gross revenue.

On the other hand, Ireit Global’s top 5 tenants contributed 78% of portfolio gross revenue as it only has 60 tenants under their portfolio. This poses a greater risk if the top 5 tenants are not established companies as they will have higher risk of defaulting their rent payments which will affect unitholders’ distribution income.

However, not all REITs which have tenant concentration are created equally. There is one REIT which only has one tenant that I am comfortable in investing - Elite Commercial Reit. It is over 99% leased to the UK Government, providing attractive and recession-proof yields. It can provide assurance that their only tenant is less likely to default on its payment.

5. Debt Profile

REITs are highly leveraged instruments and it is imperative that potential investors should look at their financial health before considering investing in it. Debt is very important for REITs and investors as this is one of the few methods that REITs will utilise to finance its acquisition plans. Whenever a REIT undergoes an acquisition, it usually utilises debt and equity to fund its purchases - with debt forms the majority of the funding to reduce the likelihood of a dilutive acquisition. Therefore, Gearing Ratio is one of the most important metrics to look at.

Gearing Ratio is the ratio of a REIT’s debt to its total deposited property value. In Singapore, REITs have a gearing limit of 50%. For REITs to raise its leverage limit to 50%, they must maintain a minimum Interest Coverage Ratio of 2.5 times. However, MAS has deferred this requirement to 1 January 2022 as it is likely that the REITs’ ICR will be under pressure in the near term due to the impact of pandemic on their earnings and cash flow.

For example, Capitaland Integrated Commercial Trust has a gearing ratio of 40.6%, a sharp increase from a quarter ago of 34.4%. This sharp increase should concern many unitholders as it either means that there is a sharp devaluation of its assets or there is an increase in borrowings. Even though MAS has raised the limit to 50%, it is prudent for management to keep its gearing ratio limit to below 40% as this means that it is less likely for the management to issue rights from its unitholders to pay off its debt.

REITs do not usually pay off its debt but refinance its existing loan for a new loan which will extend its maturity. So, REITs only pay the interest on the loans taken up and the metrics to look at is Interest Coverage Ratio. Interest Coverage Ratio is defined as the number of times its EBIT can cover the interest expense. It also determines how the REIT can pay interest on its outstanding debts. Therefore, a higher interest coverage ratio will be preferred. Having looked at multiple REITs in Singapore, it seems that REITs’ ICR are on a decline even for blue chip REIT like Ascendas Reit. For now, with the benchmark of 2.5 times set by MAS, the declining ICR is not a concern yet but unitholders should keep an eye on this metric nonetheless.

Though not as important as the other financial metrics mentioned above, a well staggered debt maturity is preferred as it gives management enough room to refinance its loans and also less likelihood to raise funds from unitholders to pay off its outstanding debt. In this low interest rate environment, we are seeing a trend where Average Cost of Debt is on a decline as shown above where CICT’s Average Cost of Debt decreased from 3.1% to 2.8%. Unitholders ought to be concerned if the REIT’s Average Cost of Debt is increasing as this means that the lender evaluation on borrower’s credit rating is poor, thus seen as more risky thus commanding a higher interest rate loan.

Lastly, I will look at the percentage of borrowings on fixed rate vs floating rate. As the Fed just announced that it expects interest rates to stay at near zero through 2023, at one glance having a higher percentage of borrowings on floating rate is preferred as REIT will be able to take advantage of the declining interest rate on its debt. However, since interest rate is already at its all time low and 10Y treasury yield is on the rise since the start of last October, I believe that it is time for REIT to be forward looking by increasing its percentage of borrowings on fixed rate and taking up longer maturity debt. This will enable REITs to lock in the low cost of debt for a longer period of time (maturity). This is because a higher cost of debt will result in an increase in interest expense and thus reduce the distribution income for unitholders. In the case of CICT, assuming an increase of 0.1% in interest rate will result in an increase of $1.6 million of additional interest expense.

Closing Thoughts

There are over 40 REITs listed on Singapore Exchange but there are only a handful of REITs that are worthy to invest in. Although REITs are attractive because it offers high distribution yield, do not be mistaken that a higher distribution yield is a more attractive investment than a REIT with lower distribution yield. A higher distribution yield REIT usually carry higher risk mainly due to its poor performance in delivering growth in DPU or NAV. Therefore, I always look for REITs with strong sponsor such as Mapletree, Ascendas, CapitaLand and Frasers Property and not touch with high distribution yield such as First Reit and Lippo Malls Indonesia Retail Trust.