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Sunday, September 27, 2015

Do You Know Your Reits Well Enough?

I discussed a lot on the Reits sector towards the end of previous year (Click Here) and then updated them again early this year (Click Here), especially on the sensitivity risk towards rising interest rate environment, and thought it is a good time to review the sectors again after some serious correction during the past couple of months.
 
Many people who looked at Reits often do very minimal research on the companies because most of the times they are looking at trailing facts. This includes looking at trailing earnings and dividends yield, current gearing ratio and present price to book value and then they start making decision based on that. The forward looking portion is often ignored, which is what successful investors should be projecting and analysing on, especially with information that are not so apparent to retail investors.
 
 
 
 
Gearing
 
For instance, I wrote an article here in the past regarding how gearing is a function of both the numerator and denominator. Many investors had considered gearing as a single function of liabilities and thought that as long as the company did not take on more debts, the gearing would not be affected. This is obviously not the case as we know that any devaluation of the property assets due to increasing interest rate environment would directly result in a correlation increase in the gearing ratio.
 
Income Support
 
Another information that are often ignored and not so apparent in the financial statement is the utilization of income support. Take Viva Industrial Reit for instance. I had readers who expressed their interests in the Reit because they are offering a double digit yield at 10.5% and decent discount to NAV. What the investor doesn't realize is there are often an expiry with these income support and when it does, the yield would drop massively to the surprise of the investor. A savy investor would usually monitor the NPI yield of the properties and ask question if the dividend yield distributed is higher than what the properties can yield out.
 
IRR
 
When I recently added Accordia Golf Trust and Ireit into the portfolio, one of the consideration was whether the freehold properties they have on their books are generating competitive Internal Rate of Return (IRR) as compared to shorter leasehold properties (such as Industrial Reits) which are generating higher IRR. This is tricky because both have their pros and cons to consider about.
 
Now, we know that based on the theory we learned in school, we need to choose a project that can generate a higher IRR for as long as present value is bigger than 0. Think about it this way. As a Reit manager, you make an acquisition for a 30 year leasehold property that can yield an IRR of 10% per annum. This acquisition is likely to be yield accretive immediately and can boost distribution to shareholders. Another Reit manager make an acquisition for a property that are freehold but only yield an IRR of 5%, which are not immediately yield accretive but can work out to be good long term investment simply because the assets are held to infinity of time.
 
It is hard to argue which is the better acquisitions because the former yield a higher IRR in the beginning and you assume that the manager can make a similar astute call on making another acquisitions that yield the same IRR when the existing leasehold expires. As for the latter, the assumption is since it is a freehold assets, it doesn't matter that it is yielding a lower IRR because time will eventually increase your returns with higher predictability.
 
 
Final Thoughts
 
I think Reits still present a good opportunity at present environment if you know how to decipher the code that is not so apparent to many other retail investors.
 
The key is to look out for hidden values and consider the risk reward ratio over the long run since we've seen some of the share price has corrected significantly from the peak. And when market mispriced them once again due to fear factor of weakening global economy, that's when we should be ready to pounce on them.


What about you? Do you know your Reits well enough?

11 comments:

  1. Good article :)

    I always compare property yields of each REIT and compare to another similar one in the same sector/type.
    I never did consider comparing to other type of REITs. It is an idea though. Reasonable to calculate it like how I calculate centrifugal force in Sciences (1000RPM for 1 min = 100RPM for 10 min), maybe 10% yield of 5 years could be compared to 5% yield of 10 years?

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    1. Hi Azrael

      I think what you are doing is right.

      We should be comparing to the properties ideally in the same sector to have an apple to apple comparison. What I was comparing was with regard to the internal rate of return using a specific example from a different reits industry.

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  2. Here are my thoughts:

    Freehold of Accordia: perhaps freehold is too overrated in that the idea is people can reuse again and again while lease hold have a limited span. Based on discounted cash flow, you will realize that for the first 20 years, the cash flow from the property comes from real returns. after 20 years, the returns starts coming from capital returns. this means the company is returning capital to you. 20 to 30 years its a mixture of capital and real returns, from 30 years onwards it is mostly capital returns.

    Discounted cash flow also says that, what you pay right now is the present value of cash flow for the next 20 years.

    IF after these 20 years, you still have things left, then that is your bonus return. for free hold and long leaseholds, this is your bonus.

    In summary, whether the property have 100 years, 90 years or 80 years left, the differential value should not be much difference.

    Why i say accordia might be misplaced is that, while the land is free hold, what about the buildings? I shudder to think that in 15 years time, you are still going to attract folks to your country club with those old buildings isn't it. similar to commercial properties, and retail mall.

    not so for some industrial properties.

    a good contrast will be cache REIT which is 36 years of landlease and likely to yield close to 9.5%. if you look at the 20 year IRR, whether the growth is 0%, 1%, 2%, 3%, the minimum irr is 7.5%.

    should we invest in accordia if irr is 5% or cache?

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    Replies
    1. Hi Kyith

      Thanks for sharing your views.

      No I totally agree with your views and see it differently after talking with you. Before that, I was always under the impression that in the mindset I can psycho my brain better thinking that the properties are freehold the better it is for the investors.

      Of course, as we all know it, the DCF probably takes into account the first 5 or 10 and then began to wane after that, probably holds true in that sense.

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    2. to be fair the way i think about it after discussing with another friend is: say MLT have 58 year land lease, and that if you get your payback within the first 20 years (if u value ev/ebitda its usually that long) the rest of the 38 years is good to have. caveat: my own thinking. could be very wrong

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    3. Sounds to me that your friend came to buy stocks with the intention of seeing it break even after X amount of years and treat anything after that as a bonus. Not that it's incorrect but I thought we all want to achieve something more than simply gunning for a breakeven, at least that's what most SMRT investors tell me. Just hold on for dear life, it will break even one day.

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    4. Breakeven but lost to inflation. :-)

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    5. hi B its more of valuation not breaking even. if you dcf or xirr for the first 20 years, you can buy a reit at a 7-8% discount rate and arrive at the current fair value. those excess years after 20 years is your CALL OPTION.

      that is a safe way of looking at it imo

      it will not be like your keppel corp or sci that keeps up with recently so well when they drop more than 30% or their great business model with the ceo trying to spin stories in the market and not tell folks how really bad the rig market is.

      Delete
  3. Hi B,

    A good reminder! I used to look at yield but now I look at sustainability of yield at least for 3 years. As it is tough to project beyond that.

    I also felt freehold is "overrated" especially for a business trust. However leasehold cannot be understated. You dun want a golf course to be expiring in less than a decade. The underlying business of management of golf-course and hence the earning power of the golf course is what I considered most important.

    I invested because I like managemeny ability to manage costs and maintain profitability although some volality is unavoidable. However I do think 9-10% yield is overkill to compensate for volality in earning which is not big. Yen is perhaps more resilent than what others think.

    The bigger risk after currency is parents' dumping ... There is no track records to speak of. Yet.

    Will be watching closely their first acquisition

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    Replies
    1. Hi SI

      I totally agree that freehold is somewhat an overrated way to use probably to bait for a premium when sellers sell them. The ability of the management to extract the value out from the properties is probably a better key indication for investors to take note of.

      The first acquisition for Accordia will be indeed key to how they are going to do the next subsequent one.

      Delete
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