How do I Conduct Fundamental Analysis for REITs?

If you have been following my blog, then you be familiar with my REITs review posts that always end with a summary table for favorable points and less favorable points. I would also conduct a comparison between REITs within a similar sector in every quarter to find out which REIT is better in various aspects. However, it does not mean that a REIT with more favorable points is better than those with fewer. It is important to know that certain metrics/aspects should weigh more during fundamental analysis.

Photo by Lukas from Pexels

So, how do I conduct a fundamental analysis? Well, a scorecard is my way to do it. Old school? Yes, it is old school. Not workable for the qualitative parts? Agree, that is why it is important to quantify as many "qualitative" parts as possible. I've always believed that good qualitative aspects would be reflected in quantitative aspects. I have previously shared this idea in 2019 in Quantifying REITs Fundamental post, where a lower score indicates favorable/lower risk and vice versa. This time, I would pick the 3 U.S. Office REITs as a case study and go through it steps by step, as detail as possible.

Basic Information

Criteria for Basic Info

From the above, business trust (Ascendas India Trust & Dasin Retail Trust) is assigned with 10 points because I deem it as less favorable due to it is not bound by REIT rules. For dividend frequency, quarterly is more favorable. 

As all the 3 are REIT and semi-annual distribution, their scores are as below:

1) Keppel Pacific Oak US REIT = 0

2) Manulife US REIT = 0 

3) Prime US REIT = 0

Lease Profile

Criteria for Lease Profile

Look confusing? I would take the portfolio occupancy as an example for explanation. 0% to less than 91% = 7 points; 91% to less than 91.75% = 6 points. This continues until 98.5%, which occupancy equal or more than 98.5% = -4 points. The same concepts apply to the remaining criteria.

Lease profile scores:

1) Keppel Pacific Oak US REIT = -7

2) Manulife US REIT = -15

3) Prime US REIT = -10.5

Debt Profile

Criteria for Debt Profile

There are 3 colors for the criteria, which each come with a different score interval. Red is what I deem as more important and have a score interval of 1.5. Whereas Orange has a score interval of 1 and Green has a score interval of 0.5.

Debt profile scores:

1) Keppel Pacific Oak US REIT = -2.5

2) Manulife US REIT = 5.5

3) Prime US REIT = -9

Diversification Profile

Criteria for Diversification Profile

So how do I assign the 0 score for different types of criteria? For most of it, I am taking the average value as a benchmark. For certain criteria like gearing and land lease expiry, I am using the values that I am comfortable with as a benchmark. And since the average values keep changing, I would revise these settings quarterly after all results are updated.

Diversification profile scores:

1) Keppel Pacific Oak US REIT = -10

2) Manulife US REIT = -6

3) Prime US REIT = -7.5

Related Party Shareholding

Criteria for Related Party Shareholding

How about the criteria interval? How do I determine it? For most, criteria intervals are close to 1/4" of their standard deviation. However, the will be some exceptional cases like this related party shareholding, where the values are scattered. In this case, I would assign the intervals on my own. After assigning these criteria intervals, I would then check the numbers of REITs that fall in the lower tier and the upper tier, ensure both numbers are balanced.

Related party shareholding scores:

1) Keppel Pacific Oak US REIT = 0 

2) Manulife US REIT = 6

3) Prime US REIT = 2

Financial Metrics

Criteria for Financial Metrics

For certain info like gearing, WALE, WADM, etc, I am using real-time values, because these are more meaningful than average values. Whereas for metrics like property yield, distribution margin, diversification profile metrics, etc, I am using weighted average values (up to the past 5 years) which focus more on the recent years.

Financial metrics scores:

1) Keppel Pacific Oak US REIT = -7

2) Manulife US REIT = -7

3) Prime US REIT = -12.5

Growth Profile

Criteria for Growth Profile

Some of the figures in this post would be slightly different from those in my comparison post because I am using the weighted average figures instead of the past 1-year average. This applies to this growth profile as well, in which I quantify the uptrend/downtrend/flat in numbers.

Growth profile scores:

1) Keppel Pacific Oak US REIT = 0

2) Manulife US REIT = 13.5

3) Prime US REIT = 6.5

Sum Up

Now, let's sum it out and adjust it to a 100% basis.

Yield factor:

1) Keppel Pacific Oak US REIT = 73.5%

2) Manulife US REIT = 97%

3) Prime US REIT = 69%

I have termed the score as a "yield factor" because that is how I would use it for fundamental intrinsic value in the later part. A 100% yield factor means I would accept the REIT with its sector benchmark dividend yield. For example, if I set office sector REIT benchmark yield as 6.5%, then I would require the min. dividend yield to be benchmark yield x yield factor: 

1) Keppel Pacific Oak US REIT = 73.5% x 6.5% = 4.78% dividend yield

2) Manulife US REIT = 97% x 6.5% = 6.3% dividend yield

3) Prime US REIT = 69% x 6.5% = 4.49% dividend yield

Of course, there are other factors to consider while doing valuation, couldn't be I would accept a perfect REIT with 1% dividend yield. I would leave the valuation topic to a future post, the concept for this scorecard is, the lower the yield factor, the better the fundamentals. 

Image by Arek Socha from Pixabay

The above criteria setting are based on my risk tolerance and preference, which would be very different from yours. Nonetheless, this scorecard method could provide a systematic way of assessing REITs fundamentals, without any bias. With this scorecard, it could answer things like, AREIT vs MIT, which is better? CICT vs FCT, which is better? KREIT vs Suntec REIT, which is better? Albeit with different criteria settings, the result would be different.

You could use Excel or Google Sheet to auto-compute the score, and save up a lot of time. If you require a template to start with, you could refer to my previous post - Quantifying REITs Fundamental. Hope you find this post useful for your REIT fundamental analysis, feel free to contact me if you need any clarification or help.