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4 Types of REITs to Avoid

·5-min read
Avoid Word
Avoid Word

Real estate investment trusts (REITs) own portfolios of properties that allow investors to gain exposure to the property market with very little capital outlay. 

On top of that, these investment vehicles usually have dividend yields that are way higher than the general market, making them even more attractive.

Having said that, not all REITs make good investments. 

Here are some types of REITs that investors should be wary of.

Highly-leveraged REITs

REITs in Singapore have a gearing ratio limit of 50%, as mandated by the Monetary Authority of Singapore. 

The gearing ratio is calculated by taking a REIT’s total borrowings and dividing it by its total assets.

The limit used to be 45% but was raised in April 2020 to help REITs to cope with the adverse impact of the COVID-19 pandemic.

Generally, I prefer REITs that have a leverage ratio of below 40%. 

This ensures that if the economy were to take a sudden downturn, there would still be a margin of safety before the 50% limit is breached.

If the 50% cap is hit, the REIT will have to raise funds through other means such as a rights issue or private placement to pare down its debt and bring its gearing ratio down to a more palatable level. 

During the 2008-2009 Global Financial Crisis, some REITs had to undertake rights issues at considerable discounts to their-then unit prices to keep their debt levels manageable.

Such rights issues resulted in massive dilution for unitholders, causing distribution per unit (DPU) to plunge.

Excessive private placements

Private placements describe a situation where a REIT sells additional units to a specific group of investors to raise funds.

Unlike a rights issue where retail investors such as yourself can participate, private placements are reserved for a select group of investors such as institutional investors or wealthy individuals.

An example of a REIT that recently conducted a private placement exercise is Ascott Residence Trust (SGX: HMN). 

The hospitality REIT raised gross proceeds of around S$150 million from a private placement to partially fund a new acquisition of its third student accommodation asset in Texas, USA. 

The placement, which comprised around 152.6 million new units, was offered at a price of S$0.983 apiece. 

The issue price was at a discount of around 5.5% to the volume-weighted average price of S$1.04 for the REIT for trades done on 8 to 9 September 2021.

It can be seen that existing unitholders were diluted as a result of the private placement as they could not take part in it. 

Any REIT that conducts excessive private placements should be avoided as retail unitholders will have their stakes in the REIT diluted in the future should more placements be made.

Declining distribution per unit

Investors in REITs should look out for consistent DPU growth.

An increasing DPU signals to the market that the REIT’s assets are stable and can attract quality tenants. 

On the other hand, a falling DPU shows that a REIT is struggling to increase rents and that its properties may have trouble attracting tenants, resulting in low occupancy rates.

For example, healthcare REIT Parkway Life REIT (SGX: C2PU), has seen its annual DPU climb from S$0.0683 in 2008 to S$0.1379 in 2020. 

In contrast, ARA Logos Logistics Trust (SGX: K2LU), an industrial REIT, has been facing headwinds and this shows up in its falling DPU over the years.

From its fiscal year ended 31 March 2016 (FY2016) to FY2020, the REIT’s DPU declined from S$0.07725 to S$0.0525.

However, in a sign that the REIT’s fortunes may be reversing, DPU for its fiscal 2021 first half (1H2021) rose 10.6% year on year to S$0.0257.

At their current unit prices, Parkway Life REIT has a forward distribution yield of 2.9% while ARA Logos Logistics REIT sports a yield of 5.7%. 

Based on their yields alone, the latter REIT looks more attractive. 

But when we look at both REITs’ DPU track record, Parkway Life REIT wins hands down.

Therefore, when investing in REITs, we should not rely solely on a REIT’s distribution yield. 

We should also look at its DPU track record to make a more informed decision.

Excessive valuation

Generally, REITs that have a price-to-book (PB) ratio of more than one are not considered cheap.

The PB ratio is calculated by taking the market price of a REIT and dividing it by the REIT’s latest net asset value (NAV) per unit. 

Any ratio above one shows that the REIT is trading at a premium to its net asset value, which is its assets minus its liabilities.

In some cases, a high premium is warranted as the REIT is perceived to be a stable one with high-quality properties that enjoy strong demand. 

An example of a REIT that is trading at a discount to its NAV is healthcare REIT First REIT (SGX: AW9U).

Note that the REIT’s DPU had plunged by 52% year on year as it restructured its master lease agreements.

At S$0.26, the REIT is trading at a 26% discount to its NAV of S$0.3512 as of 30 June 2021.

On the other hand, Keppel DC REIT (SGX: AJBU), a data-centre-focused REIT, is trading at a significant premium to its NAV.

The REIT’s PB ratio is 2.1, meaning its unit price is 110% higher than its NAV as of 30 June 2021.

The market perceives Keppel DC REIT to be better than First REIT, hence is pricing it at a higher valuation.

Thus, valuation needs to be taken in context.

While you should raise an eyebrow if the PB ratio of a REIT exceeds one, there are cases when this can be suitably justified.

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Disclaimer: Royston Yang owns shares of Keppel DC REIT.

The post 4 Types of REITs to Avoid appeared first on The Smart Investor.

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