How to Measure a REIT?

REITs are a popular inflation hedge. What are some key gauges to spot the good ones?

Kate Lin 28 July, 2022 | 8:00
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Kate Lin: Welcome to Morningstar. Singapore's core inflation in May rose at its fastest pace in 13 years. Real estate investment trusts or REITs are a popular inflation hedge, especially when dividend increases outpace inflation rate. Are there common metrics that we can use to locate good REITs? We're talking to Xavier Lee, equity analyst, at Morningstar.

Hello, Xavier. Tell us the key gauges when picking the right REITs.

Xavier Lee: Hi, Kate. Yeah, when it comes to picking the right REITs, we think that investors should focus on metrics that affect a REIT's ability to consistently grow distributions per unit over time. Having said that, I think when looking at some of the commonly disclosed operating metrics like occupancy rates as well as weighted average lease expiry profile, I'd just like to mention here that there's actually no correct or wrong or good or bad operating metrics. So, it all depends on the existing market conditions as well as the reasons that may have led to the REIT reporting such metrics.

Lin: So, can you give us an example for that?

Lee: Sure. For example, a REIT mainly report low occupancy rates of 70% because of an ongoing asset enhancement initiative, which on the surface a low occupancy of 70% may look bad compared to the market where everyone else is doing 90%. However, the REIT may be able to lease up the empty units at a much higher rent after the completion of the asset enhancement initiatives. So, the higher rents that they have achieved together with the improving occupancy rate, this will together flow through as higher dividends for investors over time. So, ultimately, I think a REIT's ability to grow its dividends over time is one of the most important things to look at, and I also believe that there will be a positive knock-on impact on its valuation as we have observed historically.

Lin: So, let's move on to the very hot topic in Singapore, rising costs. It also means higher income from the rental side. But do you see such increases starting to be reflected on REITs that you cover?

Lee: I think the answer to this would be yes and no. So, on one hand, the determination of rental rates is largely subjected to the market forces of demand and supply, which I think is especially true for office and industrial real estate. But I believe there may be some exceptions, such as retail REITs that charge a percentage of its tenants' turnover. This may potentially be a good inflation hedge as they take a cut of any higher prices charged by their tenants to the shoppers. Of course, some office and industrial landlords may also build in rental escalations that are tied to the consumer price index, allowing them to increase their rents annually by the percentage change in the consumer price index. However, such practice is rare in Singapore and probably more common in European countries like Germany. So, investors who are keen to ride on the inflationary environment can look for sample REITs that own overseas assets with leases that track the consumer price index.

Lin: Right. Thank you so much, Xavier. For Morningstar, I'm Kate Lin.

 

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Kate Lin

Kate Lin  is a Data Journalist for Morningstar Asia, and is based in Hong Kong

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