Singapore is one of Asia’s largest REIT and property trust markets and S-REITs have become an important segment of the Singapore stock market.
But of the 43 S-REITs listed on the Singapore stock exchange, only 5 made it into the Straits Times Index. What gives?
You might also like
In this article, I’ll share why not all REITs are built the same, and hopefully give you a framework (aka “virtuous vs vicious patterns“) to identify the best REITs for your portfolio.
But first:
Definition of a ‘good’ REIT investment
We regard some REITs as top tier investments. They often have the following characteristics:
- valued at a premium, with higher price-to-book ratios and lower dividend yields when compared to their lesser competitors,
- yield higher long-term annualised returns,
- provide shareholders with stable dividends and increased DPU and NAV annually,
- have top quality assets,
- are backed by well-capitalised sponsors and sound management.
How to analyse REITs
There is no lack of information on the internet understanding and analysing REITs.
But in this article, I want to present a unique perspective of how the top tier REITs enjoy a virtuous cycle where things keep getting better for them while the weaker REITs are in a vicious pattern.
To do this, we will compare two top performers versus the bottom two performers. This will help illustrate how the best REITs continuously grow through well-received acquisitions while weaker REITs are unable to do the same.
Top performers versus bottom performers
We identified the top and bottom performers based on the data of 10-year annualised total returns provided by SGX as of 30 November 2021. Annualised total returns encompass share price appreciation and dividends.
The top two performers are:
- Mapletree Industrial Trust (MIT) (SGX: ME8U) with 16.4% CAGR
- Parkway Life Real Estate Investment Trust (PLife) (SGX: C2PU) with 15.9% CAGR
Meanwhile, the two bottom performers are:
- Lippo Malls Indonesia Retail Trust (LMIRT) (SGX: D5IU) with -10.3% CAGR
- First Real Estate Investment Trust (First Reit) (SGX: AW9U) with -1.7% CAGR
What does their CAGR mean for investors?
A 16.4% CAGR works out to an approximate return of 4.56 times. Simply put, every $10,000 invested in MIT 10 years ago is worth $45,600 now. On the other hand, you would be left with $3,400 if you invested in LMIRT.
This is a 13x difference!
It could lead to early retirement for investors who invested in MIT and extended working life for those invested in LMIRT.
Would you do okay if you had picked ‘average’ S-REITs?
In comparison, the 10-year total returns for the FTSE ST REIT Index and STI were about 2.6 times and 1.5 times, respectively. These represent CAGRs of roughly 10% and 4%.
This means that only 10 REITs outperformed the STI.
Further, only 7 REITs outperformed the REIT index.
What exactly is the “virtuous and vicious cycle”?
Before I share the answer, I want to show the 10-year share price movement plotted against the book-value-per-share and earnings yield of the top two and bottom two performers.
Why earnings yield?
The earnings yield includes valuation gains/losses and is used instead of the more commonly known distribution yield.
We know that REITs need to distribute at least 90% of their distributable income to qualify for tax transparency. From empirical evidence, we also know that most REITs distribute 100% of their income. That is, except in certain situations leading to retention of distribution income.
An example of this is the cash conservation measures enacted by many REITs during the peak of the COVID-19 period. Nonetheless, most of these REITs have since distributed these amounts back to unitholders after they found themselves in a relatively stable position.
Thus, the earnings yield should have explained the increase or decrease in net asset value. However, the data shows us that it does not. There is one more major factor at play here.
The major factor at play: virtuous and vicious cycle
The major factor at play is the virtuous and vicious cycle for REITs. This refers to trading at a price-to-book ratio that is substantially above 1.0x and a price-to-book ratio below 1.0x, respectively.
The REITs valued at a premium can acquire high-quality assets that are accretive both from a distribution yield and NAV perspective. Sometimes, with exceptional structuring, the REITs can even reduce leverage.
With the added debt headroom from a reduced aggregate leverage ratio, they can carry out more acquisitions to increase their DPU and distribution yield.
How the virtuous and vicious cycles look like in practice
In the following slides, we will show the pro forma financial effects of acquisitions carried out by these four REITs.
- Good REITs reap benefits of acquisitions
We can see that the acquisition for PLife was not only DPU yield and NAV accretive; it even reduced gearing. Meanwhile, MIT’s acquisition was also DPU yield and NAV accretive.
These two REITs have carried out so many acquisitions in the last two years that investors have wondered if they will ever stop doing so. Of course, they wish that the acquisitions would never actually stop.
- Weak REITs do not
First REIT’s and LMIRT’s acquisitions were not NAV accretive. LMIRT’s deal even had to rely on vendor support for a meaningful DPU accretion.
A unitholder should not be disadvantaged on a highly dilutive rights issue if he subscribed to all units allocated to him. However, First REIT’s latest acquisition was funded by private placement to the sponsor. It means that minority unitholders such as retail and institutional investors did not have an option to avoid dilution by subscribing to the units.
It is clear that the sponsors of these underperforming REITs are in a hard place. Due to weak existing assets, the REITs will continue to underperform if they do nothing. Meanwhile, as rights issues are highly dilutive, minority investors are unhappy about needing to cough up more money.
Still, if the REITs decide to do a private placement instead to placate such investors, some would view the sponsors as self-serving and disadvantaging other investors.
It is also apparent that the market reacts negatively to such acquisitions. Stock prices and P/B valuations continue to decline despite the DPU yield accretive acquisitions.
Conclusion
It is clear that on a 10-year time frame, REITs that outperformed are regarded as top tier, with the ability to grow their DPU and NAV consistently over the years. These REITs, namely PLife and MIT, are in a virtuous cycle where every acquisition has led to the share price going higher.
Such REITs are recognised by investors, thereby expanding their valuations and leading to a share price growth that outran their NAV growth.
On the other hand, the underperformers are in a vicious cycle where every move they make can be viewed negatively. This leads to lower book values and, more notably, lower share prices.
I hope this framework gives you a way to analyse S-REITs and their acquisitions going forward. If you’re looking to add more REITs to your portfolio next year, read my S-REITs outlook for 2022. If you’re looking for some REITs to start researching on, I have also picked out the best S-REITs to invest in 2022.
If you want to dive deeper into REITs and stocks to build a dividend paying portfolio, join Christopher Ng at his live webinar to learn how investors like you are retiring early on dividends.
