When I started investing in REITs about a year ago, I started to Google articles on what are the criteria to look for in a fundamentally sound REIT. I read a couple of books as well. The very basic, of course, is the return on investment. The thing to look for is an increasing distribution per unit (DPU) year after year. At a minimum, it should not be a downtrend. This is very true for retail REITs because a downtrend only indicates complacency of the REIT manager, to a certain extent.
However, the same rule cannot be applied for Al-Hadharah REIT, a plantation (oil palm) REIT which is largely affected by the fluctuation of CPO prices. An investor in a plantation REIT should know the nature of the palm oil business and be prepared for the risk associated with it. As you can see, it is easy to generalise things without understanding the whole picture.
The same can be said for asset acquisitions. We know that any REIT which is actively growing its portfolio would get a lot of attention in the investor community. This is a general sign of a viable investment as the manager is doing the right thing. This is not wrong, but it is also not fair to apply the same rule to all REIT classes.
Now let’s go back to REIT portfolio growth – I think in Malaysia, no other REITs can beat the growth story of Axis REIT. It had been aggressively acquiring quality warehouses and industrial properties for the past few years. From 5 to 31 properties (as of Dec 2012) since 2005 – a staggering growth indeed. Then you look at AmFIRST REIT; its asset portfolio grew from 4 to 9 buildings in a period of 7 years since its inception. Just looking at the number alone, a layman would conclude Axis REIT is better managed than AmFIRST, but nothing can be further than the truth.
When I first talked to the CEO of AmFIRST REIT, Mr. Lim Yoon Peng, he explained it to me that office assets are lumpy, and they just couldn’t just go on a shopping spree by raising private placements just like Axis REIT did. The cost of acquiring office buildings is substantial, and it just couldn’t be done by doing private placements (limited to 20% of a fund existing capital). And we are not talking about any office assets – the ones that are suitable to be injected into a REIT normally refer to prime office buildings, preferably in the CBD area.
Then again, you wouldn’t want a REIT manager to just acquire assets just for the sake of growth if the asset does not yield accretive. Or, you cannot expect Capita Malls Malaysia Trust to acquire your local shopping malls beside your house.
Speaking about yield, I often get asked by members of my REITMethod.com program if it still makes sense to invest in office REIT when the yield is still attractive (6-7 percent). Their main concern is the nature of office properties as office buildings are facing an oversupply problem. We don’t need to be a commercial property expert to know this – just read some analyst reports or a section in a REIT annual report which contains independent research reports from renowned property managers.
This is what I think – if the REIT manager of an office REIT is keeping a check on its maintenance cost (aka Property Expenses item in the Income Statement) from rising on par or more than its Net Property Income, then all is good. The importance of tenant retention and negotiation of tenancy renewals, hopefully with positive rental reversion, is of utmost importance. The rest is just noise. This information doesn’t get published in newspapers nor can you Google it, so doing your own homework and using common sense to understand the business is crucial.
As with any landlord, the longer your tenancy lease agreement is, the more secure your rental income. In this aspect, every REIT class has its norm in its lease duration. For example, a healthcare REIT lease duration is normally 15 years. You could not say the WALE (Weighted Average Lease of Expiry) of 2 to 3 years for a retail REIT is bad. Why? Because 3 years is the norm for retail property. This will enable the retail REIT manager to proactively refresh and optimize the retail mix, bringing in new concepts to ensure its shopping malls continue to stay relevant to shoppers as retail trends evolve.
The nature of the REIT business is another topic that commands much interest. If you ask me, I’d rather contend with a 6% distribution yield holding onto a localised retail REIT stock rather than a hospitality REIT stock with overseas assets giving a 7% yield. For the layman, a higher return is better, right? Wrong.
Firstly, the hospitality sector is cyclical and when there is an outbreak like SARS, this sector would be the first to feel the impact. Second, overseas assets are subject to foreign exchange risk. With these 2 things in mind, a prudent investor would forego the additional 1% extra return because the uncertainty associated with is just not worth it.
Of course, a good REIT Manager will set the game rule so that the rental received from the overseas asset is denominated in Ringgit, besides fixing the rental income received from the hotel operators regardless of actual guest occupancy rate.
As they say, safety does not come with what we invest, but with how much we know about what we invest.
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