Re-looking into REITS

The recent bearish sentiment that plagued the stock market actually opened up many opportunities for serious investor who have the capacity to take a long term view. Rational investment during such bear market market will reap respectable returns when the bull returns, even if one does not catch the bottom. Such is just a regular recurring phenomena in boom-bust cycles as I had mentioned in my earlier article. In fact, quite a number of stocks have corrected to a level not seen since 2004. Many claimed to miss the boat during the last irrational exuberance prior to Aug 2007, yet so few are willing to pick up the same stock at a fraction of the price they claimed to miss.

Tip-off from e-mail

I received an e-mail regarding my view on REITs, given the recent correction. I recall a few years back when REITs suddenly clogged the limelight for being capital protective yet delivering relatively high yields. Their prices had appreciated quite a bit and lost their attractiveness in terms of yields. With the recent sell down that plagued almost every sector, they seems to look attractive again.

Some research

On the surface, REITs seems to be simple enough to understand. Their underlying assets are buildings and their revenue are lease or rental income which, after expensing all fees and expenses, are distributed to shareholders. More on REITs and business trust in general can be found on SGX website. Comparison amongst the many REITs can be found on a very informative blog, SGX - REIT Data.

A look beneath the skin

Yields

At the price they are trading, quite a number REITs are delivering yields above 8%. The question is whether this yield is sustainable. A typical REITs will have to take on a sizable debt to purchase the land and buildings and refinance them every 2 to 3 years. Hence their interest expense are subjected to change. Lease income, on the other hand, tend to be fairly stable as many usually have long term lease contracts with the tenants. The risk to the yields are then the variable expenses for the REITs and the default risk of the tenants. Given current high rentals, it won't be surprising if a number had to vacate for lower rentals else where.

Net Asset Value

Net Asset Value (NAV), or Net Tangible Assets (NTA) less intangibles, compared to share price are usually a guage whether the stock is trading below value or not. Quite a number of REITs are already trading below their NAV. At first glance, this might seems to mean these are undervalued, but a closer look tells a different picture. The main asset of REITs are their land and buildings. Their prices can be quite sentiment driven. During property gloom (between 2002 to 2005), most property are going at depressing levels. But only after 2006, their prices started to rocket and the bubble only started to deflate recently. Thus, the NAV of REITs are just as volatile as sentimental property prices.

Risk

Given the high leverage (common also to shipping trusts) securing funding is crucial to the survivable of REITs. Thus their ratings are of paramount concern. This is the reason why Allco REIT had to go all the way to take legal action to fight a lowering of their rating by Moody. Downgrading of a rating not only jeopardizes refinancing, but also make it harder (or more expensive) to raise debt for more acquisitions.

On my watchlist

Screening through the various REITs, I have decided to place cambridge industrial REIT into my watchlist. I would not consider a purchase if the yield does not cross 12%, the minimum I desire for any investment. The attractive nature of cambridge are (quoted from its annual report):

1. Diversified industrial portfolio in many sectors, manufacturing, service & commerce etc.
2. Long term lease of 5 to 15 years
3. Strategically located properties in key industrial zones spread across Singapore
4. Built-in rental escalations to provide organic growth
   

Conclusion

While it is still too soon for me to go into REITs now, sub 10% yield is still not attractive enough, I believe this bear market is still at its infancy and hence could create more attractive opportunities in months to come. Patience are always rewarded.