REITS Investing 101: Understanding the different types of REITs
For the dividend
investor, real estate investment trusts (REITs) have been extremely popular
over the last decade for their, giving both capital and dividend gains to
investors who hold them.
Photo credits: Seedly |
Retail REITs
One advantage of
retail REITs is that for most investors, it is easy for you to do your
scuttlebug due diligence by simply going to their malls. Take some time to
observe the location, mall architecture, tenant mix and type of shoppers. With
such information, you can obtain a first-hand idea of the earning power of that
mall, unlike other REITs where observing the property from within can be
difficult or even prohibited.
“A hallmark of a vibrant
retail REIT is one whose management is proactive in organizing events, holding
competitions and actively engaging people to come into their malls. Suntec REIT
(T82U.SI) is an excellent example; the REIT holds multiple entertainment
events, invites celebrities to meet and greet with fans, hold competitions,
host international conferences, and organize sale bazaar fairs and travel
roadshows to continue to make their shopping malls lively.”
Ideally, you’ll
want to invest in retail REITs that own malls and shopping centres which consistently draw in the crowds and have the potential to continuously revise
rental rates upwards.
Hospitals and
nursing homes are underlying assets of healthcare REITs. The master lessee of
these properties (the main tenant who rents the entire hospital) usually takes
care of all property operating expenses, taxes and insurance of the property.
The leases of
healthcare assets are generally long term, usually longer than ten years. For
instance, National Health Investors Inc. (NYSE: NHI) generally sign 15-year
leases on each of their portfolio assets.
Be it for small
accidents or major emergencies, hospitals and healthcare offices will always be
in demand and are fairly recession-proof. This is why healthcare REITs are often
trading at a premium and continue to show a solid and steady return on
investment even during a recession.
If you’re
thinking about investing in overseas healthcare REITs, be sure to ask yourself
these two questions before investing: Does this overseas healthcare REIT have a
track record of managing healthcare assets in a cash-flow positive manner? Does
the REIT have a reputable parent?
Quantitative
observation-wise, look at the “Rent over EBITA” ratio of the hospital operator.
This is the total rental divided by earnings before interest, taxes,
depreciation and amortization. It’ll show you how much of its cash generated
goes towards paying the rental owed to the REIT (the lower the ratio, the
better).
“Many unitholders do not
have the financial capability and time to do due diligence on an overseas
hospital asset. However, one can simply use Google Maps and observe where the
hospital is located. Is it easily accessible? Is it in or near a major city or
dense population base? Are there many other hospitals around in proximity?”
Business parks,
flatted factories, show houses and warehouses are often categorized as
industrial REITs, which offer higher yields relative to other REIT classes (but
also with risk).
Smart investors
tend to pick industrial properties that are adaptive and well-equipped to serve
big-business clients. Easy access to wide roads or highways (for logistic
purposes), built-in high floor-loading capabilities, high ceiling heights and
wide column spans are some examples of highly desired industrial assets for big
companies.
It is important
to also look at the tenants as you will want to find large and reputable
tenants. Otherwise, no matter how long the contracted lease term is, it is of
no value to the unitholder. Generally, industrial REITs who have a 60% or
higher exposure to reputable MNCs are deemed to be considerably “safer” to
invest in.
Hospitality
REITs are usually one of the most vulnerable as they are easily affected by
external factors such as spread of diseases, terror attacks, economic
recessions and layoffs, etc. In light of this, some hospitality REITs do
negotiate a master lease agreement with a hotel operator which provides for a
minimum fixed revenue amount. An example is OUE Hospitality Trust (SGX: SK7),
which pledges a minimum yield of 4.5% simply due to the master lease agreement
they’ve contracted with their hotels.
Another real
threat is the rising popularity of Airbnb, which is an online platform allowing
people to list and rent their own homes and apartments to travellers. This has
had an adverse impact on hotels, and in a recent study conducted by HVS, hotels
lost more than $400 million in direct revenues per year to Airbnb in 2015.
Unlike other
REITs who undergo renovations and AEI (asset enhancement initiatives) to
upgrade themselves for higher future DPU, hospitality REITs have to undertake
enhancements even if they’re not always yield-accretive, simply because they
need to continuously keep up with appearances and standards.
The key metric
to determine the earnings potential of a hotel is to calculate the revenue per
available room, or “RevPAR” – the average daily rate (ADR) multipled by the
average occupancy rate (AOR). The higher the RevPar, the better. Lower RevPars
generally indicate that the hotel has many rooms under-utilised or even left
empty for significant periods of time, which is not ideal.
“An investor looking to
take advantage of an upcoming tourism boom in a country should go for
hospitality REITs that have negotiated a larger proportion of their lease
structure on the variable side. Vice versa, an investor looking for more
stability in the sector should go for hospitality REITs with a higher fixed
portion in their lease structure.”
A good office
REIT will usually have their office buildings located in notable business areas
that are easily accessible by public transport and cars. Given the high skyscrapers
and swanky exterior, many investors are drawn to the idea of investing in REITs
that collect rental from reputable MNCs, financial institutions and other
corporations.
However, what
many people do not realize is that office REITs are actually highly cyclical
and can be more sensitive to economic headwinds than their retail REIT
counterparts. For instance, during the great recession from 2008 – 2011, many companies
consolidated their branches and halted expansion plans. This led to a severe
oversupply of rentable office space, causing all NYSE-listed office REITs’ unit
prices to plummet. When the economy recovered after, occupancy rates then rose
back to the 90% range again, which led to a rise in their office REITs’ unit
prices.
“Look for office REITs with
management who are focused on tenant retention as well as tenant attraction,
with the desire to maintain a long and healthy lease expiry profile which will
provide sustainable returns to unitholders like yourself over the long run.”
Given the
cyclical nature of office REITs, it is important to recognize the stage of the
economic cycle in which you’re investing. Do not make the mistake of being
seduced by the high rental income achieved during strong market periods. It
pays to think like a contrarian.
In summary, the
industrial, hospitality and office REITs are inherently more risky than other
REITs due to their assets’ sensitivity to economic headwinds. The silver
lining, though, is that such volatility can offer gutsy investors the
opportunity to buy these REITs at a cheaper price and be duly rewarded during
market upturns.
Additional reading: The success story of REITs
Additional reading: The success story of REITs
Disclaimer: This informative article was written in collaboration with Ivan Ho, author of the Investing in REITs masterclass. If you’re interested to learn more about REITs and how you can develop a new source of passive income from investing in them, click here for a discount on the above REITs masterclass!
2 Comments
Hello! I see that you mentioned Suntec is a retail REIT but it was categorized under commercial.How about Starhill? Should it be under retail too?
ReplyDeleteBoth Suntec and Starhill rent out retail and office spaces. So you can classify them as either retail or commercial REITs, if you want to be really sure, then look at which segment contribute more to the REIT's DPU. So if Starhill has more retail contributing to the DPU, then classify it under retail and look out for retail headwinds that might affect Starhill's DPU. etc
ReplyDelete