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.
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.
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.
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.
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?