A Smart Guide to Investing: An Introduction to REITs Part 2

2021-04-17     thesmartinvestor
A Smart Guide to Investing: An Introduction to REITs Part 2

We hope you enjoyed Part 1 of our introduction to REITs!

We explained what REITs are and why they are such an attractive asset class for income-seeking investors.

This is the second of a three-part series where we take a tour of the REITs area, and delve into what makes a REIT attractive.

We cover two main areas in this article — the different types of REITs available and the metrics you should look at to determine if a REIT is good to own.

Types of REITs

REITs can be broadly classified into five main categories — hospitality, retail, industrial, commercial and healthcare.

Investors should note that there may be overlaps for certain REITs as they may hold a mixture of properties that belong to different property categories.

Hospitality

Hospitality REITs own a portfolio of income-producing hotels and service residences.

Some examples in Singapore include Far East Hospitality Trust (SGX: Q5T), or FEHT and Ascott Residence Trust (SGX: HMN), or ART

At the end of 2020, FEHT owned a portfolio of nine hotels and four serviced residences, all located in Singapore.

In contrast, ART is a global hospitality trust that owns 86 properties in 38 cities around the world, as of 31 December 2020.

Hospitality REITs are dependent on tourism flow and demand and may be impacted adversely if these are disrupted, such as during the current pandemic.

Retail

Retail REITs typically own a portfolio of shopping malls.

Examples of retail REITs include Frasers Centrepoint Trust (SGX: J69U), or FCT, and United Hampshire US REIT (SGX: ODBU).

At the end of 2020, FCT owned a portfolio of 10 suburban retail malls located in the heartland areas of Singapore.

United Hampshire, on the other hand, owned 18 grocery and necessity-based malls along with four self-storage facilities in the US, as of 31 December 2020.

Retail REITs are tagged to consumer demand and footfall and are also sensitive to economic conditions.

They do well during booms but their tenants may face difficulties in servicing their leases during recessions.

Industrial

Industrial REITs own a portfolio of properties that are used for industrial purposes. These may include industrial warehouses, logistics facilities, data centres or business parks.

Examples of industrial REITs include Mapletree Industrial Trust (SGX: ME8U), or MIT, and Ascendas REIT (SGX: A17U).

At the end of 2020, MIT owned a portfolio of 111 properties that include data centres, flatted factories and light industrial buildings.

Meanwhile, Ascendas REIT’s portfolio comprises 200 properties spread out across the UK, US, Singapore and Australia, as of 31 December 2020.

Industrial REITs that have high-quality properties and strong tenants tend to be more resilient during crises.

Commercial

Commercial REITs own a portfolio of office properties.

Some examples of commercial REITs include OUE Commercial REIT (SGX: TS0U) and Manulife US REIT (SGX: BTOU).

At the end of 2020, OUE Commercial REIT owned seven properties, six in Singapore and one in Shanghai.

In contrast, Manulife US REIT owned a total of nine office properties located in the US, as of 31 December 2020.

Commercial properties tend to be rented out to corporate tenants but in light of the pandemic pushing more employees to telecommute, companies may revisit their space requirements as time goes on.

Healthcare

Healthcare REITs own healthcare-related properties such as hospitals and/or nursing homes.

A good example of a healthcare REIT is Parkway Life REIT (SGX: C2PU).

At the end of 2002, the REIT owned a total of 54 properties in Asia, of which three are hospitals in Singapore, 50 are nursing homes in Japan, and strata-titled lots in a specialist clinic in Kuala Lumpur, Malaysia.

Healthcare REITs tend to remain resilient during crises as their assets enjoy consistent demand in good times and bad.

As mentioned earlier, these are strict classifications for REITs but many REITs own a mixture of properties belonging to more than one category.

For instance, Mapletree Commercial Trust (SGX: N2IU) owns both retail and commercial properties while Frasers Logistics and Commercial Trust (SGX: BUOU) owns a mix of commercial and industrial properties.

Important metrics for REITs

Next, we look at several commonly-used terms for REITs.

Investors should find these terms being used in REIT press releases and presentations.

Assets under management (AUM)

Assets under management, or AUM, refers to the total market value of the properties managed by the REIT.

Gearing ratio

A REIT’s gearing ratio is its outstanding debt as a percentage of its total portfolio value.

Singapore REITs have a gearing ratio limit of 45% set by the Monetary Authority of Singapore (MAS). This limit was raised to 50% in light of the COVID-19 pandemic.

Cost of debt

Also related to the gearing ratio is the REIT’s cost of debt. This refers to the REIT’s interest expense as a percentage of its total debt. Stable REITs backed by strong sponsors often enjoy a lower cost of debt.

Distribution per unit (DPU)

Distribution per unit, or DPU, is the amount of money a unitholder is entitled to receive per unit of the REIT owned.

Occupancy rate (current and committed)

The current occupancy rate of a REIT refers to the percentage of its net lettable area (NLA) that is currently rented out to tenants. The NLA of a REIT by area refers to the total floor space the REIT owns that is designated for renting out to generate income.

The committed occupancy rate also includes properties where leases have already been signed with tenants but whose leases have yet to commence.

Rental reversion rate

When leases are renewed, there may be a change in agreed rental rates. An increase in rental rates would translate to a positive rental reversion for the REIT, while the converse would be termed negative rental reversion.

REITs with strong sponsors that are in an industry with strong leasing demand should witness consistent positive rental reversion, reflecting the attractiveness of their properties due to their location and physical attributes.

Weighted average lease to expiry (WALE)

Weighted average lease expiry or WALE measures the average time it takes for the REIT’s leases to expire.

A longer WALE would imply more income stability for the REIT, while a shorter WALE could mean the REIT is exposed to negative rental reversions and sharper fluctuations in occupancy rates in the near future.

Get Smart: Risks and how REITs grow

In the final section of this guide, we take a look at the various methods REITs use to grow their portfolio and DPU.

We also highlight some of the salient risks faced by REITs and how you should monitor them.

Stay tuned!

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Disclaimer: Royston Yang owns shares in Frasers Logistics and Commercial Trust.

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