For many retail investors, it is usually the mouth-watering yield offered by S-REITS that first catch their attention. It is well known that REITS as an asset class provides one of the best dividend yields in the market. For Heartland Boy, he was first attracted to REITS as he was tasked to build a dividend portfolio for Heartland Girl. Based on Heartland Girl’s investment profile, she prefers investing in equities with low beta and high dividend yields. (nothing wrong with that though) This kick-started a journey whereby Heartland Boy started to learn the fundamentals of the REIT industry, as well as the very complex jargon often used in this sector.
Heartland Boy finally purchased his first REIT/Business Trust, i.e. Croesus Retail Trust, in June 2015. That obviously has a very happy ending, with Heartland Girl happily cheering at the privatization price. Incidentally, when Heartland Boy did his mid-year 2017 portfolio review in July, he realized that he has had a very good run with REITs so far. He decided to be more disciplined and systematic so that this segment can slowly developed into his area of competency. Similar to the way he chooses his Singapore stocks, he has a set of Fundamental Analysis criteria to invest in the best Singapore REITS.
1. Consistent DPU Growth
Don’t be fooled by headlines that screams X% increase in revenue or net property income. When REITs listed in Singapore focus on these headlines during their results announcements instead, it may suggest that Distribution Per Unit (‘DPU’) have not been up to expectations. Consistent DPU growth illustrates that the REIT can be depended upon to provide a stable stream of income, which is a critical consideration for pension funds and retirees. More importantly, it is a reflection of the track record of the Manager managing the REIT. After reviewing the Singapore REITS (‘S-REITs’) listed on SGX, here are a few REITS that have demonstrated impressive DPU growth.
(Source: Frasers Centrepoint Trust)
Frasers Centrepoint Trust has an unblemished track record since its IPO. It even went through the Global Financial Crisis unscathed. This speaks volumes about its Manager and its portfolio. (Causeway Point)
Source: First REIT
This chart illustrates that FIRST REIT has shown 18 consecutive quarters of DPU growth.
Source: Lippo REIT
Heartland Boy bought Lippo REIT just before it announced its 1Q16 results. It has demonstrated several quarters of DPU growth and gave enough suggestions that this will continue.
2. Alignment of Manager’s Interest To Unitholders
Managers are ultimately the caretakers of the properties in a REIT. They make important decisions such as buying, leasing, and financing the properties. As a unitholder of a REIT, your sole interest is to see sustainable and solid growth in DPU. Therefore, you would like to hire a Manager who is aligned to your interest. This is a critical aspect when choosing to invest in a good S-REIT. For REIT investing in Singapore, it is possible to check this alignment of interest by analyzing how the Manager’s fees are structured.
Broadly, a Manager is paid a base fee as well as a performance fee. However, there are several benchmarks to dictate how much they are paid. Different barometers used could lead to Managers pursuing different objectives.
Let’s compare the fees structure of REIT A and REIT B. REIT A and REIT B both earn base fees pegged at 0.5% of the valuation of the deposited property. For illustration sake, if the deposited property has an aggregate valuation of S$1 billion, this implies a base fee of $5 mil. However, REIT A and REIT B differ in how they incentivize the Manager.
The performance fee for Manager of REIT A is pegged as a percentage of Net Property Income. For instance, if REIT A generates $100 mil in net property income (‘NPI’) in 2016, the Manager would be entitled to $3 mil in performance fees for 2016. In 2017, if REIT A generates $120 mil in NPI, the Manager will earn $3.6 mil in performance fees. If the additional NPI is a result of the Manager scouring the market to find a better-paying tenant or brainstorming on creative ways to reduce operating expenses, then the higher performance fee is well-deserved. It makes perfect sense. Cynically, the fee structure also potentially incentivizes the Manager of REIT A to behave in this manner as illustrated below.
Example of a yield-dilutive acquisition
Manager of REIT A did a massive rights issue to raise funds to acquire Property X. As a result, the dividend yield decreased from 10% to 9% which is obviously the last thing you want as a unitholder. Perversely, the performance fee for the Manager increased to $3.6 mil from $3mil after the acquisition. Therefore, a performance fee that is pegged to portfolio’s valuation, revenue, net property income etc incentivizes the manger to acquire more properties to grow the base in order to earn a higher fee. This could lead to the sponsor acquiring properties irresponsibly, leading to yield-dilutive acquisitions. As such, this represents a clear departure from an alignment of unitholders’ interest since the objective to maximize returns for unitholders has been lost in the process.
While not exactly perfect, the fee structure for REIT B is an improvement over REIT A as the performance fee is pegged to the growth of DPU. Growth in DPU is ultimately what a unitholder wants and in this case, there is a clear alignment of interest between the Manager and the unitholders of REIT B.
3. Competency of Manager
Having explained the importance of the integrity of the Manager, it is just as important to evaluate the capability of the Manager as well. That is because a property in an excellent location can be ruined by a sub-par Manager, just as well as how a competent Manager can squeeze every juice out of a poorly-located property. It is possible to judge the competency of a Manager on a few operational metrics; (i) the acquisitions the Manager makes, (ii) occupancy of portfolio (iii) WALE of portfolio etc. From time to time, a Manager may propose an Asset Enhancement Initiative (‘AEI’). Some examples would be developing extensions to the shopping mall, refurbishing the common areas of an office building etc. Here are some examples of Managers executing AEI that have been yield-accretive for the unitholders.
The Manager of Croesus Retail Trust did a major AEI for Mallage Shobu, a major suburban shopping mall located in Satiama, Japan. After the AEI was completed, it managed to secure higher-paying tenants and increase the mall’s footfall with a more refreshing tenant mix. The REIT was able to enjoy double-barreled boost to DPU as there was also a variable component to some of the tenant’s leases.
Closer to home, Viva Industrial Trust undertook a major AEI for Technopark @ Chai Chee by converting ground floor carpark and untilised area into retail and commercial space. During the process, it convinced Decathlon and Harvey Norman to set up its first store and factory outlet in Singapore respectively. As a result, the business park was transformed into a “work-play-eat-shop” destination within the Chai Chee neighbourhood. It was subsequently renamed Viva Business Park. Besides converting unutilized area into revenue generating area, the spillover effect of this transformation is the ability to command higher rents for its business park space. This is most evident when it achieved 7% positive rental reversion for Viva Business Park in 2Q2017 as compared to the industrial average of 2%. The market has definitely taken notice and Viva Industrial Trust remains one of the best performing Singapore REITS in 2017.
4. Comfortable Gearing
Besides evaluating the competency of a Manager from the operational perspective, it is equally important to consider the capital markets component. REITs listed on the Singapore Stock Exchange are regulated by Monetary Authority of Singapore (‘MAS’). REITS are not allowed to have a gearing of more than 45%. A low gearing ratio implies that the REIT is not over-extending itself. More importantly, low leverage equates to firepower for the REIT to acquire yield-accretive acquisitions. On the flip side, a unitholder may be asked to participate in rights issue (coughing out more money) to fund prospective acquisitions if the REIT already has a gearing that is uncomfortably close to the allowable limit.
A competent Manager will also proactively renew loans so that the debt maturity profile is comfortably long and well spread out. This diversifies the risk of interest rate spikes in a particular year. In addition, Heartland Boy prefers his Manager to manage interest rate risk by hedging or taking fixed loans.
5. Future Growth Drivers
Having evaluated REITs by looking at the rear-view mirror so far, it is important to evaluate if the distributions can be increased in the future. This is almost the last check before buying a REIT that you have shortlisted. Several components can drive DPU growth. As aforementioned, an AEI done well can spur DPU growth. Similarly, a lower cost of debt can lead to millions of interest expense saved. Heartland Boy would like to highlight the importance of considering the macroeconomic situation so that you can invest in the best Singapore REITs.
It is well known that the industrial sector in Singapore is facing a downturn. It boils down to simple economics – demand growth simply could not catch up with supply growth.
Business Park achieved positive rental reversions in 2Q2017 (Source: JTC)
However, it would be too presumptuous to tar Viva Industrial Trust with the same brush. Viva Industrial Trust has 2 major business parks which are poised to benefit from an industry uptrend as it will be facing tight supply in the coming years. Heartland Boy’s investment thesis is panning out well as the Business Park segment eked out a positive rental reversion in 2Q17.
Lippo Mall Trust finds itself in a similar demand-supply macroeconomic situation. Heartland Boy expects positive rental reversion for its properties in Jakarta.
Very low supply forecasted in Jakarta (Source: JLL)
6. Sustainable Competitive Advantage
Besides favourable macroeconomic conditions, it is critical to consider microeconomic factors as well. A sustainable competitive advantage can come from the location of the asset or the branding of the Manager. For instance, Vivocity (Mapletree Commercial Trust) is truly one of a kind. It is the major shopping mall in the South, surrounded by several office buildings, and also the gateway for tourists looking to enter Sentosa. By virtue of its strategic location, the Manager has strong pricing power. Likewise, there will be no shortage of tenants queuing up at Paragon (SPH REIT) if they are looking to seriously enter the luxury sector in Singapore.
Invest In The Best Singapore REITS
Heartland Boy has listed 6 factors that he considers before he invests in the best Singapore REITS. If choosing individual REITs counters does not appeal to you, why not consider Syfe REIT+? Syfe REIT+ offers a hassle-free way to invest in the top 30 REITs in Singapore with its low fees perfect for a dollar-cost averaging strategy.
Good post. This is the first time i heard Croesus manager as being called competent
Hi Kyith,
Thanks! I think we can assess it from various aspects. I give credit to them for doing a great job with the AEI at Mallage. Also credit for its capital markets policy. Of course, they could have overpaid themselves during the internalisation. But without the internalisation, there would be no privatisation offer. Definitely not perfect in all aspects, but generally competent in my own assessment.