Guest Post - Correlation of SREIT Metrics

This is a guest post contributed by KW from @investingnugget

From the "Comic Strip - Basic Metrics of REITs" post by REIT-TIREMENT, several key REIT fundamental metrics were brought up. In this post, we will build on that, and look at how to interpret these metrics intuitively. Real data will also be used to illustrate key points, and to show how the different metrics are related to each other.

1) Dividend Yield

Logically, a riskier investment would warrant higher potential returns, in the form of higher dividend yields, as a form of compensation for the investor. Think of it as "High Risk, High Returns" in a way.

2) P/NAV Ratio

In an ideal world, if a counter gets delisted/taken private, the assets would be liquidated/sold, and the proceeds returned to investors. In this sense, a P/NAV of 1 would mean that if a counter is delisted, investors will get back whatever money they put in. Hence, a riskier investment would reflect in a lower P/NAV ratio, as investors are not keen to pay more than the valuation of the underlying properties, for safety reasons.

Both dividend yield and P/NAV can be thought of as a measure of how much confidence investors have in the outlook and stability of the REIT. The ratios are directly influenced by the current market price and can be used to compare across counters. While market capitalization is also directly influenced by the current market price, it is not as straightforward to use it as a metric for comparison across counters.

Based on the understanding above, we plot yield and P/NAV, and see the expected inverse relationship.

Case Study:

(a) Keppel DC REIT appears in the top left of the plot, with low yields (investors do not mind earning less) and high P/NAV, reflecting investor's confidence in the only pure-play data centre REIT listed in Singapore.

(b) Lippo Mall REIT and First REIT both appear in the bottom right corner, with high yields (investors demand high risk compensation) and low P/NAV, reflecting investor's lack of faith in the counters, due to financial woes.

3) Market Capitalization

Market Cap is derived from the counter's market price and the number of outstanding shares. As such, Market Cap fluctuates with the daily price movements and is not exactly a reflection of the value of assets like NAV measures. However, it is usually a good enough proxy and is commonly used as a measure of how large/valuable a counter is.

We see that there is yet again another inverse relationship between Market Cap and Dividend Yield. Based on our previous logic, this means that investors view larger REITs as safer/less risky. This makes sense as larger REITs enjoy greater stability as they are not reliant on a single tenant for their income.

Case Study:

(a) First REIT appears on the top left this time, with a high dividend yield (investors perceive it as high risk) with a low Market Cap. While First REIT is somewhat of a unique case with recent developments, it perfectly encapsulates the "small REIT, less diverse" notion, with most of their rental income coming from one party.

(b) At the opposite end, CapitaLand Integrated Commercial Trust is the largest REIT in Singapore by Market Cap, at over S$10B. Ascendas REIT has many properties and many tenants spread across different countries.

4) Gearing

A REIT's gearing measures how leveraged the REIT is, by comparing how much debt there is against the total asset value. Together with Interest Coverage Ratio, gearing can provide a decent overall picture of the REIT's loan situation.

One would imagine that the more debt that a REIT takes on, the riskier it would be to invest in it, and should justify a higher yield. However, as we can see from the plot above, there is no clear relation between dividend yield (perceived risk) and gearing. This is because gearing by itself does not reflect much about the REIT, with the following things for consideration:

1. Bad Debt vs Good Debt

If the REIT can secure debt at low interest costs, it might be worthwhile to do so. Along the same line of reasoning, if the debt allows for the purchase of high-quality assets, it might be wise to do so and increase gearing in the process. The common term for good debt decisions is "yield accretive", for your information.

2. Debt is NOT the only Way.

Since REITs are mandated to distribute most of their rental income to shareholders, they rarely keep much cash on hand. When a potential acquisition comes by, the REIT will have to raise funds. While a high gearing (close to the regulatory limits) will prevent the REIT from taking on loans to raise funds, this does not mean that the REIT will never be able to get enough cash to buy new properties. REITs can raise funds through other methods such as rights issues (although this will take more time). Hence, a high gearing does not fully prevent REITs from expanding and growing and is not that big of a deal.

5) Sector Analysis

We retrieve historic sector yields from https://www.reit-tirement.com/2020/01/sreits-basic-fundamental-review-2020-1q.html

The line in blue shows the current average dividend yield for each sector, and the dotted orange line shows the average yield back in Jan 2020, before COVID blew up.

Here is our take on explaining some of the changes. There are many things that could influence the yield in each sector, but we will just point out a few main points here:

Hospitality - Yield dropped drastically as tourism basically ground to a halt for the majority of 2020. While prices have dropped, it was not enough to compensate for the plunge in rental income, hence the lower yield currently. Why did stock prices not drop as much as rental income? Perhaps investors could be looking ahead and pricing in recovery soon with vaccine rollout.

Industrial - Yield dropped as industrial counters suffered some minor drop in rental due to COVID, but prices did not drop (in fact many have fully recovered/surpassed pre-COVID prices) as the setback is perceived to be short-lived. Yield is also compressed as several Industrial REITs (KDC, MINT) have stakes in Data Centres, which are gaining in popularity in recent years due to the potential of cloud computing.

Office - Slightly higher yields. While rental income has been quite robust (companies can work from home, but the rental contract is already in place), the prices have dropped to reflect a weaker long-term outlook for office space, as many companies have tried WFH arrangements out of necessity.

Retail - Slightly lower yields, as DPU dropped with rental rebates given to tenants. Share prices recovered quite well as investors subscribed to the idea that domestic demand would be resilient, coupled with vaccine rollout.

Conclusion

By stepping through key relationships one by one, I hope that you now have a clearer understanding of how to interpret Dividend Yield, P/NAV Ratio, Market Cap and Gearing. Understanding the basics is key to safe, sustainable dividend investing. In the last segment, we also looked at how the different sectors/flavors of REITs fared through 2020's COVID crisis, which can hopefully let you better position yourself for the future.