InvestingNote Interview Series: 8 questions with Dehong

InvestingNote Interview Series: 8 questions with Dehong

Previously, we ran a vote on the questions that you, a retail investor can ask and get an analyst for it to be answered.

So, here are the 8 questions that were selected to be interviewed with Dehong, PhillipCapital’s analyst who specialises in REITs and property counters.

1. Is a REIT with a larger portfolio of freehold properties better than another REIT with a portfolio of shorter leasehold properties?

Land tenure is only one consideration but just by looking at the land tenure of the REIT portfolio alone is insufficient to conclude if the portfolio is better or worse. Usually if we compare like-for-like two properties in the same vicinity, one with a freehold tenure vs another with a shorter leasehold, the freehold building usually trades at a lower cap rate (i.e higher valuation, valuation is inversely related to cap rate) than the shorter leasehold property. So the NAV of the REIT would have already priced in the freehold factor. Another example of REIT pricing already reflecting the shorter land tenures is this: one of the reasons industrial REITs trade at higher yields is due to the fact that industrial properties in Singapore tend to have shorter 30-year leases vs retail or office properties. The higher yield compensates investors for the shorter tenure and lower potential for capital gains over the long run.

2. We know REITs are leverage plays, how would you calculate and compare their metrics and duration vs fixed income in falling, flat, rising interest rate environments?

Unlike fixed income, REITs do not have fixed “maturities”, so calculating a duration that measures the sensitivity of the REIT’s price to fluctuations in interest rates in not as straightforward. Unfortunately this bond metric is not a concept I’ve explored before in using to price REITs. An easier metric for investors to watch out for instead is the sensitivity of the REIT’s earnings (not price) to fluctuations in interest rates or forex movements in the annual report under “sensitivity analysis”.

3. What metrics do you use to evaluate if a particular REIT manager is a good or bad one in relation to shareholders’ interest?

At the end of the day, a consistent track record of DPU growth and proven ability to carry out AEIs with heathy ROIs to return decent yields on costs in the long run is important. Fees as a percentage of revenue can be one of the metrics to look out for as well but typically this number fluctuate between 5-10% unless boosted by one-off acquisitions or divestments. Eventually these fees impact DPU so an important consideration is how much of an impact outsized fees (if any) have on DPU. Consistent healthy DPU growth is key. Of course, a manager with average industry compensation who grows DPU at above sector average rates is best, but I would not mind paying higher management fees to a team who is able to grow earnings better than sector pace. REIT managers who acquire non-accretive properties or “churn” properties for acquisition/divestment fees would likely struggle to maintain DPU growth over time.

4. Is book value a good way to judge if a REIT is under or over valued? If not, what are the good ways to judge it? Could you then bring us through some blind spots that REITs investors need to make aware of in property valuation reports, so they can make informed choices?

Price/NAV is one metric to determine valuation of a REIT but on top of comparing across the industry vs peers, it is useful to compare over a REIT’s own historical P/NAV too. Big cap REITs typically trade at higher valuations than smaller REITs. Mapletree Industrial for example trades at an average Price/NAV of 1.22 post GFC. Reasons being these big cap REITs typically are able to obtain lower costs of funding, which makes it easier for accretive acquisitions. They also enjoy economies of scale in the management of a larger portfolio. So, a cross sector comparison would be more meaningful, if you compare with a basket of similar size market cap peers instead of widely across the sector. Even similar size companies can have portfolios with different geographic exposures too so it is important to take that into account when comparing. When comparing over its own historical P/NAV investors should note if the macro environment is similar to the historical period and whether changes in the environment can justify it trading at a premium/disc to the average over the historical period.

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