How I Evaluate S-REITs: Are They a Buy Right Now?

Ah yes, Real Estate Investment Trusts (REITs), an asset class the Singapore stock market is very well known for. There is no denying that Real Estate, whether you like it or not, will remain an integral part of Singapore's economy. For those unaware, REITs are companies that own and operate a portfolio of real estate buildings, redistributing a minimum of 90% of taxable income back to shareholders in the form of dividends. In Singapore, REITs typically make use of leverage to beef up their portfolios. Hence, the Monetary Authority of Singapore (MAS) mandates that REITs adhere strictly to a gearing ratio of below 50%. That is to say, REITs should not borrow more than 50% of their net asset value, which will be incredibly pertinent for reasons I will get into later on. Additionally, REITs are typically held for dividend income, as opposed to price appreciation, since their high payout ratio leaves little room for reinvestment. 

I know I repeat this ad nauseam, but we seriously need to consider how are REITs being impacted right now by high-interest rates and a possible economic recession. To be very honest, I'm only rather concerned with the former, as I believe that even with a recession, portfolio occupancy rates won't dive down too deeply. 

To evaluate whether a REIT is a good value proposition for me, I consider several factors, in no particular order:

1. Dividend Yield

2. Portfolio Occupancy

3. Rental Reversions

4. Geographical Location of Assets

5. Gearing Ratio

6. Percentage of Fixed Debt

7. Interest Coverage Ratio

8. Weighted Average Maturity (WAM) / Weighted Average Lease Expiry (WALE)

9. Industry 

10. Sponsor/Management

I will further go on and elaborate on my rationale for why each factor matters, using a rather popular REIT, Mapletree Industrial Trust (MIT) as a case study.

1. Dividend Yield

When you are investing in a REIT, you are investing for the cash flow (at least in usual cases). In my opinion, if a REIT, which pays most of its earnings in the form of dividends, cannot even yield more than the Singapore Savings Bond (SSB), which is rather liquid and virtually risk-free, then I don't see any point in investing. In recent times, the risk-free rate is yielding at around 4.0%, not too shabby. 

At MIT's current price of $2.430, its trailing dividend yield is at 4.66%. When I see this figure, the immediate thought that comes to mind is that the yield spread between the risk-free rate and MIT is only 0.66%. Is 0.66% additional yield commensurate for the equity risk that you are placing yourself in when investing in MIT as opposed to SSB? I don't think so. Hence, MIT fails this criterion of mine.

2. Portfolio Occupancy

A high portfolio occupancy usually indicates that tenants are doing well, and hence can continue making rental payments, generating income for the REIT. Additionally, it is a reflection of the quality of the REIT's assets. A run-down, badly maintained mall will most likely fare poorer than a pristine condition mall in a high-traffic location. The same goes for offices, industrial buildings, whatever it is. 

We'll take a look at MIT's most recent Q3 FY2022/23 results which is a portfolio occupancy of 95.7%. To me, this is rather acceptable, especially when you consider the average occupancy rate for Singapore industrials which is 89.7%. From this, we can conclude that MIT is making good use of its real estate assets, which is a positive sign. MIT gets approval from me for this aspect.

3. Rental Reversion

Positive rental reversions mean that when a tenant's lease expires and is subsequently renewed, the new agreed-upon rental is higher than the previous one. A high positive rental reversion rate indicates that the assets of the REIT are high quality, and hence, not easily substituted, and/or the tenants are doing extremely well and hence are able and willing to adapt to the higher costs. 

MIT's recent positive rental reversion rate 2QFY2023 is approximately 2.6%, which to me is acceptable. Nothing fantastic, but nothing bad either. Overall, I will give MIT a passing grade for this criterion of mine.

4. Geographical Location of Assets

The geographical location of REIT assets is extremely important since you have to factor in foreign exchange risk, socio-political risk, the macroeconomic condition of the country, and more. REITs that have assets in stable and safe countries are favoured in my books. Take, for example, China. It seems as if the government is rather fickle in its position on the Zero-Covid policy. Although it isn't too likely for the government to reinstate such policies, given the rather severe strikes, one must not discount the possibility of something similar happening again. If such drastic measures were to be put in place yet again, then surely, the performance of tenants, and by extension REITs' performances will take a hit. 

According to MIT's official website, it owns 85 properties in Singapore and 56 properties in North America. Personally, I like a Singapore-centric asset location. Hence, with the majority of MIT's assets being located in Singapore, I would be able to sleep rather soundly. Additionally, I see no problem with having assets in North America. I don't see any region-specific headwinds that would impact business operations drastically. Overall, MIT gets a pass from me in terms of asset location.

5. Gearing Ratio

All REITs must adhere to the 50% gearing ratio limit set by the MAS, lest they are forced to liquidate assets ASAP to reduce gearing. One need look no further than the recent Manulife US REIT debacle when Manulife REIT's gearing skyrocketed up to 49% due to the depreciation of its assets. Indeed, it seems like the REIT is walking on a fine line. When such a situation occurs, it is highly likely that the REIT does a dilutive rights issue, which forces shareholders to cough up cash for additional shares of the company to reduce gearing or sell assets at a fire sale due to the urgency of the matter, which does no favours to anyone since Net Asset Value (NAV) is not fully realised. Furthermore, REITs with low gearing ratios can afford to acquire more assets, should a good opportunity present itself, further increasing distributable income. 

Using Q3FY2023 figures of MIT, it's currently at a gearing ratio of 37.2%. There is a relatively large margin of safety between this figure and the regulatory limit. MIT investors can sleep well at night knowing that this REIT is not at risk of any fire sales or right issues any time soon. A good rating for me.

6. Percentage of Fixed Debt

Fixed debt is debt that has a fixed interest rate. Since we just got out of a time of historically low-interest rates, any REIT with a high amount of fixed debt will continue experiencing low-interest payments. In essence, a high percentage of fixed debt would mean that the REIT is essentially insulated from the high-interest rate environment we are currently in.

According to MIT's Q3FY2023 debt profile, approximately 74.3% of MIT's borrowings are fixed. I would say that the management did not capitalise on the low interest rate opportunities that were previously present. 74.3%, albeit not terrible, is still rather on the low side. I think I don't really like MIT's performance on this end. 

7. Interest Coverage Ratio

Interest Coverage Ratio (ICR) is a metric that measures the numerical multiple of interest payments a REIT's earnings can cover. A high ICR would mean that the REIT can keep up with interest payments very easily, and hence be at a very low risk of insolvency.

MIT's ICR comes in at around x5.3, straight in the middle of the pack. Nothing to comment on here. MIT gets a pass for this one. 

8. Weighted Average Maturity (WAM) / Weighted Average Lease Expiry (WALE)

The market is forward-looking. The percentage of fixed debt, and interest coverage ratio, don't mean anything when the debt profile changes. WAM is the weighted average time to maturity for a REIT's debts. A low WAM would mean that a significant portion of the debt is maturing soon and hence needs to be refinanced at new terms. Currently, this would mean that previously fixed, low-interest rate borrowings could turn into high-interest ones. Likewise, portfolio occupancy also means nothing if tenants' leases expire soon. WALE measures the weighted average of tenants' lease expiries.

MIT has a WAM of 3.1 years and a WALE of 3.9 years. In my opinion, this is a rather good WAM/WALE. In terms of WAM, I believe that interest rates could come down from their peaks in mid-2024, hence, by the time most of MIT's debts expire, they will be able to refinance them at more desirable rates. Additionally, with a high WALE of 3.9 years, MIT is not really at risk of low portfolio occupancy any time soon. However, such a high WALE is also a double-edged sword, as it presents fewer opportunities for the trust to attain positive rental reversions. MIT gets a good rating from me here.

9. Industry

Certain industries are more defensive than others, no doubt about it. For example, during the COVID-19 pandemic, many office and mall REITs such as Keppel Pacific Oak US REIT and Frasers Centrepoint Trust respectively were severely impacted due to the heightened measures each of their respective countries took. On the flip side, there are certain defensive industries such as data centers which will most likely be always in demand for the foreseeable future and do not require much in-person involvement. Additionally, it is extremely costly for companies to shift their operations from one data center to another. Hence, positive rental reversions are more easily made in industries like data centers.

MIT's portfolio consists mainly of light industrials and (recently) data centers. Indeed, it seems like the asset class of MIT's portfolio is rather defensive, which puts it in a favourable light for me. 

10. Sponsor/Management

A strong sponsor can inject high-quality assets into a REIT and also render financial support in times of crisis. Furthermore, strong sponsors have strong negotiating power when it comes to loans, resulting in a more favourable and palatable debt profile for the REIT. One should also not discount competent management with interests that align with shareholders. The management should not simply lay on their laurels or see minority shareholders are cash cows, harming and diluting them via rights issues. They should also be on the constant lookout for accretive deals for the REIT in opportune moments, striking when the iron is hot.

Mapletree, the sponsor of MIT, is a behemoth of a sponsor with a total of 78.7 billion SGD assets under management. Taking a look at the history of MIT, there have only been 2 recorded right issues in 2011 and 2021. This seems to be quite okay when considering the long time frame between the two issues. Overall, MIT receives a pass here from me.

Final Thoughts

You may be thinking why I have not mentioned anything about Distribution Per Unit (DPU), Net Property Income (NPI), Operating Expenses, etc... This is because I believe that as long as the above ten metrics are okay, the rest will follow. Additionally, when one invests in a REIT, they must ensure that the metrics listed as above are not in a downtrend (or uptrend if it's related to debt or anything negative).Overall, Mapletree Industrial Trust receives a stellar 8/10 score from me. One could even say that I am a prospective investor at MIT.

However, at the current prices, I think SREITs as a whole are still not attractive. 

At current prices, most REITs are priced as if the macro environment has not deteriorated one single bit. There is a bit of a time lag for REIT earnings to be adversely affected by the economic climate, and I believe that the market is still not pricing in the potentially exorbitant expenses incurred by REITs during this time. If REITs as a whole drop by around 10% at current prices is when I will think they start to look attractive. 

To end off, I am personally looking to add MIT at around the price of 2 to 2.200 SGD each. This price target of mine would require MIT to fall considerably. However, do note it is simply a price I would find MIT as a "must-buy". I don't think I will be going overweight on REITs in the short term, but I am still considering adding more units of United Hampshire REIT into my portfolio, albeit being a low priority.

P.S. I'm sorry if there's not much analysis on my part for this post. This post serves as more of me giving insights into how I value such a prevalent asset class.  Additionally, this will be the last post of January, and will most likely post a bit less for a few months due to additional commitments.

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Disclaimer: Please take everything published within this blog with a pinch of salt. Nothing I say here should be misconstrued as any form of financial advice whatsoever. In fact, I am probably the absolute last person you should approach for any sort of advice. All self-computed figures are calculated to the best of my ability, but I cannot guarantee they are 100% accurate.