How to evaluate and analyse Reits

How to evaluate and analyse Reits

If you’ve only got a minute:

  • Understand both the S-Reit landscape and factors that affect the performance of Reits before investing.
  • Economic outlook affects S-Reits in varying sectors (commercial, healthcare, hospitality, industrial and retail) differently
  • Yields, interest rates, weighted average lease expiry and net asset value are some useful metrics to evaluate Reits on

Real Estate Investment Trusts (Reits) are often heralded as an attractive investment for dividend seekers and it is easy to understand why. Reits provide investors with an avenue to gain ownership of a wide range of properties both locally and globally at low entry costs.

With property prices steadily rising, Reits can be considered an alternative to purchasing an investment residential property while generating income for you.

In Singapore, Reits are required by law to distribute 90% of their income as dividends to unitholders. These distributions are also tax exempt.

In recent years, most Singapore-listed Reits (S-Reits) have averaged dividend yields of between 5% and 6%, making them more appealing than government bonds and term deposits, even as we might be seeing interest rates rise in 2022.

6 key things to consider when evaluating Reits

Among property investments, Reits are unique in that, unlike traditional real estate investment, Reits trade like stocks. Through Reits, you are essentially investing in a portfolio of income-generating properties.

As investment instruments that exhibit some stock-like behaviours (i.e. trading on exchanges, being very liquid and providing dividends), Reits are often analysed much like stocks though there are some differences.

As with most things in life, do your due diligence by understanding the S-Reit landscape and taking note of some key points before jumping into your first Reit investment.

1. Economic outlook

Like stocks, the state of the economy is an important factor affecting the performance of Reits. Stronger economic growth prospects are generally a good thing.

That said, most Reits have mandates that focus on a particular sector – Commercial, Industrial, Healthcare, Hospitality and Retail. This means you are best placed to understand the outlook of the individual sectors.

Here are some examples of what to look out for in Hospitality, Logistics (a subset of Industrial properties) and Retail Reits:

When it comes to diversified Reits, be aware of the combined outlook of sectors that properties in the portfolio form. Let’s take the example of a diversified Reit which has commercial, hospitality and retail properties in its portfolio. You should look at the outlook of each sector when considering investing in the S-Reit. It is also helpful to look at how each sector contributes to overall revenue collected by the S-Reit.

For S-Reits with mandates that require them to invest mostly in foreign property (e.g. Manulife US Reit and Cromwell European Reit), understanding the economic and property outlook in those countries can go a long way to helping you decide on when the right time to invest is.

2. Yield and frequency of payouts

A favourite measure used by dividend seeking investors is yield which is related to the risk potential and growth prospects of a Reit. Historical yields are calculated by taking the distribution or dividend per unit in a Reit paid to investors divided by its current unit price.

Higher yields do not make a particular Reit more attractive and may indicate a lower chance of stable distributions. Conversely, lower yields are not indicative of a Reit being a less valued buy and might actually represent a safer investment.

Historical yields are also not indicative of future performance of a Reit. That said, they can be a useful measure in understanding how consistent a Reit has maintained its payouts to unitholders.

In some cases, the frequency of distributions made to unitholders may affect whether individuals choose to invest in one Reit over another. Those who prefer more regular payouts may pick a Reit that pays quarterly distributions over one that pays semi-annually.

3. Interest rate environment

Reits may react to increases or decreases in interest rates. It is generally said that rising interest rates make bonds, dividend income stocks and Reits less attractive.

A higher interest rate environment makes the higher dividend yields of Reits less attractive to holding cash deposits and other fixed income securities.

If expectations of future interest rates change suddenly, Reits along with other asset classes have often faced high price volatility.

That said, historical data has shown that a rising interest rate environment does not necessarily result in the underperformance of Reits. For the most part, Reit returns and interest rates have actually had a positive correlation. This is so as a rising interest rate environment is often associated with economic growth and higher inflation. These two factors are likely to be a positive for property-related investments.

A lower interest rate environment may actually present an opportunity for Reit managers to refinance loans ahead of their maturity at a lower rate as well as take up new loans for future expansion.

But there is a caveat: if interest rates are falling because of a coming recession, they won’t help the prices of dividend-paying stock or Reits.

4. Weighted average lease expiry (WALE)

The WALE is one of the main metrics used to assess the health of a Reit. It measures the average time to expiry of existing leases of properties in a Reit based on the area a tenant occupies and the rent it pays to the Reit. If a Reit’s WALE is 4.5, this means current leases have an average of 4.5 years before the end of the contract.

That said, do not look solely at the absolute value of this figure in making an investment decision. For example, a lower WALE for an Industrial Reit during a period of strong economic growth should not be viewed as a negative, especially if the supply for industrial property is tight and new rental contracts can be signed at a higher price.

Likewise, a longer WALE can be an assurance to investors during an economic downturn as the tenants are locked into their tenancy agreements for a longer time.

5. Net Asset Value (NAV)

NAV, the difference between total assets and liabilities on a per unit basis, is another commonly used metric to assess the valuation of a Reit. NAV is indicative of the value of a Reit portfolio on a per unit basis.

Theoretically, if the NAV per unit of a Reit is S$1.50, each unit should trade at that price. However, this is rarely the case as Reits mostly trade at a premium or discount to their respective NAVs.

6. Funds from operations (FFO)

When it comes to stocks, investors often look at net income and earnings per share as a gauge for how much a company makes.

These traditional avenues to measure earnings for companies might not be the best approach when evaluating Reits.

FFO is a measure that you can calculate to better evaluate the cashflow from operations of a Reit. In essence, it measures the net amount of cash and equivalents that flows into a Reit portfolio from regular, ongoing business activities.

This measure is often cited as one of the more important metrics to understand when investing in Reits.

Summing up

While not exhaustive, these 6 factors represent a good place to start when evaluating which Reits to invest in.

Take the time to read up on each Reit so you can make more informed decisions and are comfortable with investing Furthermore, do bear in mind your risk tolerance and asset mix in your portfolio.

This is the last article in our series on S-Reits. If you’re keen to learn more about Reits, check out the other articles:

Part 1: The basics of Reits

Part 2: The S-Reit landscape

Part 3: Practical ways to invest in Reits

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Disclaimers and Important Notice
This article is meant for information only and should not be relied upon as financial advice. Before making any decision to buy, sell or hold any investment or insurance product, you should seek advice from a financial adviser regarding its suitability

All investments come with risks and you can lose money on your investment. Invest only if you understand and can monitor your investment. Diversify your investments and avoid investing a large portion of your money in a single product issuer.

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