Heartland Boy has enjoyed some modest success with the Real Estate Investment Trust (‘REIT’) and Business Trusts that he has invested in so far. Including dividends and unrealized profits, Croesus Retail Trust, Lippo REIT and Viva Industrial Trust have returned 35%, 29% and 8% respectively since his investments. Croesus Retail Trust is on track to become one of the best REITs for 2017. However, it wasn’t all always a bed of roses. When Heartland Boy first interned in a REIT in 2012, he felt like a helpless captain lost in sea. He was overwhelmed by all the unfamiliar terminology thrown at him. Thankfully, he had a very patient mentor who guided him well. He also acquainted himself better by reading Module 10 of Capital Markets and Financial Advisory Services (‘CMFAS’) and REIT investing books during his internship. Having gone through this experience, he empathizes with retail investors who might get intimidated due to their unfamiliarity with Singapore REITs. Too often, the jargon used can be quite perplexing. Therefore, Heartland Boy has decided to pen a basic 101 REIT glossary guide for dummies explaining the definition of basic terminology used. This is a collection of must-know terms that every investor should be familiar with regarding the REIT industry. Hopefully, this will help all retail investors to better understand REIT jargon when investing in Singapore REITs.
What Is A REIT And A Business Trust?
A REIT is a collective investment scheme that owns and operates income-producing real estate/properties. The regulatory regime for REITs in Singapore was established in 1999 by the Monetary Authority of Singapore (‘MAS’). Meanwhile, a Business Trust is a trust that runs and operates a business enterprise. In very broad terms, the regulations governing a Business Trust are more loose and flexible compared to the framework regulating REITs in Singapore. Because of the government’s efforts to develop the REIT market, Singapore is one of the most mature REITs market in Asia Pacific. Tax-friendly rules and a well-defined framework have attracted global REITs such as IREIT, Manulife US REIT and BHG Retail REIT etc to list on the Singapore stock exchange.
How Does A REIT Work?
REITs and Business Trusts are very popular investment options for dividend investors who are seeking regular dividend payouts. Most of them are also approved under the CPF Investment Scheme. Therefore, it would naturally appeal to investors such as retirees or pension funds that depend on regular payouts to supplement incomes. In its most basic form, a REIT owns a portfolio of properties that generates rental income.
- An Investor purchases units in the REIT from the stock exchange and becomes a Unitholder as a result. In return, the unitholder is entitled to the distributions paid out from the REIT.
- The Manager provides professional competency in managing the REIT. For instance, the Manager will be responsible for leasing and maintaining the property. In return, the Manager is paid a fee for rendering such services.
- The Trustee provides trustee services such as ensuring compliance and ensuring unitholders’ rights are protected. In return, the Trustee is paid a fee for the services rendered.
As the business model above shows, a unitholder effectively becomes a passive landlord that receives rental income generated from the properties owned by the REIT. This tugs at the heartstrings of those who wish to become property landlords but are deterred by the big ticket purchase required of properties. It is therefore no surprise that REITs do amazingly well in property-mad Singapore. They provide an opportunity for retail investors to gain exposure into real estate assets with relatively low investment capital.
Even with the business model explained, it can still be difficult for novice investors to understand the jargon used in the REITS industry. Therefore, Heartland Boy has developed a glossary of REIT jargon that comprises of essential must-know terms for anyone investing in Singapore REITs. To ensure that these terms become even more relatable, Heartland Boy also supplements it with his own analysis and examples. He highlights what to look out for when analyzing these metrics. A more in-depth article on Heartland Boy’s REIT investment philosophy and how he chooses and invests in the best Singapore REITS can be found here. Hopefully, this combination of articles will be helpful in improving your basic knowledge in REIT investment.
Glossary Of REIT Terms Explained
For ease of reference, this glossary segments the jargon into different categories (distributions, acquisitions, asset management, so that it is easier for you to look them up when required.
1.Distributions and Fees
Distribution Per Unit (DPU)
Payment paid to unitholders of the REIT. The distribution typically comes from the cashflow generated by the properties that the REIT owns.
Heartland Boy explains: Conceptually, this works exactly like how dividends are paid by companies. For obvious reasons, the higher the DPU, the better for the unitholder. You would also want to invest in a REIT which has demonstrated a track record of improving DPU. For instance, Lippo Mall REIT has demonstrated 7 consecutive quarters of DPU growth as at 1Q2017. Do also note that in trying to conserve cash, a REIT may sometimes provide the option of receiving your dividends in scrips.
These are fees paid to the Manager for managing the properties in the REIT.
Heartland Boy explains: The fees paid to the Manager may come in various forms. Typically, the Manager will collect a base fee (fixed) and a performance fee (variable). A Manager may also charge an acquisition or divestment fee when buying or selling properties. Regardless, it is important to assess that the fees are aligned to unitholders’ interest since a big fee will reduce the income available for distribution to unitholders. Sometimes, a Manager may also charge fees when securing a tenant (marketing fees) or for maintaining the property in a good condition (property management fees). The rationale is that these fees would have been incurred anyway if these services are outsourced to external third parties.
The fee payable to the Trustee for performing the duties laid out in the REIT’s trust deed.
Heartland Boy explains: Under the framework regulating REITs in Singapore, all REITS must appoint an independent trustee. However, this is not required of business trusts.
This is the ratio of Net Operating Income to the Property Asset Value. This is often called the cap rate for short.
Heartland Boy explains: If the target acquisition has an annual net operating income (revenue less operating expenses) of $100,000 and the purchase price paid is $1 million, it has a cap rate of 10%. Cap rate is important as it immediately explains whether a target acquisition is likely to be beneficial for the REIT.
An accretive acquisition is a purchase of an asset that will increase the company’s earnings per share. In the REITs context, an accretive acquisition must increase the DPU. This happens because the yield provided by the underlying property is higher than the yield required to fund the acquisition.
Heartland Boy explains: If the yield achieved by the new property is 8%, existing dividend yield of the REIT is 6%, all-in cost of REIT’s debt is 3%, the acquisition is likely to be accretive. The REIT can raise the funds via (i) rights issue/private placement whereby the market only expects 6% yield, or (ii) take on more debt at 3% interest rate or (iii) a combination of both (i) and (ii). As the sources of funding are all lower than the net property yield of the target acquisition, the acquisition will be accretive.
Sale and Leaseback
A sale and leaseback is a scheme whereby the vendor of a building sells the building to the REIT (purchaser). Immediately after the transaction is completed, it becomes a paying lessee by leasing the same building back from the REIT for its own use.
Heartland Boy explains: The sale and leaseback model is most common in industrial REITs whereby the owner of the industrial building requires the building for its operations. It is able to monetize the asset and go asset-light by selling the building to the REIT.
The vendor of a building may provide rental support or rental guarantee to a REIT when it is selling the property to the REIT. This allows the REIT to draw down on the rental support scheme to boost the underlying performance of the property. The REIT requires such rental support so as to ensure that it is making a yield-accretive acquisition.
Heartland Boy explains: A rental support or guarantee scheme is a form of financial engineering and can be very dangerous to ignorant unitholders. It is important to analyze the actual performance of the property against the artificial income provided by the rental support scheme. When the rental support or guarantee expires, the distribution per unit can drop if prevailing operational conditions cannot make up for the shortfall. In the case of Viva Industrial Trust, the counterparty providing the rental support has filed for bankruptcy. Therefore, Viva’s DPU may drop if it does not quickly improve the performance of the underlying property to make up for the shortfall.
3. Asset Management
Asset Enhancement Initiative (AEI)
Actions done by the Manager on the properties of the REIT. It could range from minor actions such as sprucing up the office lobby, renovating common areas or to major actions such as developing new extensions to an existing shopping mall.
Heartland Boy explains: This is just a sexy term used by the Manager of REITs. All AEI costs money and therefore it is important to evaluate if the additional money spent is “worth it”. Some malls are able to command higher rents by carving up smaller spaces from larger spaces after an AEI.
Weighted Average Lease Expiry (WALE)
Weighted average lease expiry is measured across all tenants’ remaining lease in years, and is often weighted with either the tenants’ occupied area or tenants’ rent.
Heartland Boy explains: This is a metric used to measure the risk of the property’s portfolio going vacant. When a property is vacant, there is no rental income and hence no distributions can be paid to unitholders. Therefore, the longer the WALE, the better it is. Croesus Retail Trust has a WALE of 6.5 years, which is comfortably long to provide security to unitholders. The downside of a high WALE is that the REIT is unable to capitalise on high prevailing rental rates during a market up-cycle since the leases are not due for renewal yet.
A master lease is a controlling lease under which a lessee rents a large amount of space in the property from the landlord at a single price. The master lessee may be entitled to divide the space and sub-lease the property to other tenants at other rates.
Heartland Boy explains: Master leases are typically signed for long periods and hence increases the WALE. Since a master lease is for a large space, the rental rates are much lower. (bulk discount) However, the REIT misses out on higher rental rates during bullish periods since the rent with the master lessee has already been locked in much earlier and for a long period of time. To take into account inflation, the REIT and master lessee may agree on a pre-determined increase in the rent at regular intervals.
Triple Net Lease
A triple net lease is a lease agreement on a property whereby the tenant agrees to pay 3 layers of expenses:
- Maintenance Cost
- Property Tax
- Building Insurance
on top of the usual fees such as rent and utilities.
Heartland Boy explains: A triple net lease is beneficial to the REIT as it ringfences the REIT’s against rising operational costs.
A lease agreement whereby there is a variable component such that the rent is allowed to fluctuate. In retail leases, it is common for landlord to collect a percentage of the tenant’s gross turnover (GTO) in addition to a fixed rent.
Heartland Boy explains: A variable rent allows a REIT to be exposed to both upsides and downsides. For instance, if the REIT manager is able to increase the footfall of a shopping mall, it is likely that the retail shops will enjoy higher revenue. As a result, the REIT is entitled to a larger monthly rent.
4. Capital Markets
A rights issue is a right, not an obligation, for existing unitholders to purchase more units of the REIT at a discounted price in proportion to their existing shareholding.
Heartland Boy explains: While existing unitholders are presented an opportunity to buy more units of a REIT at a discount, unitholders who choose not to do so will suffer from a fall in share price and get diluted as well. This is known as the TERP (theoretical ex-rights price) In addition, a REIT is likely to resort to raising money from equity markets when its gearing ratio is dangerously high to the permitted threshold. That is why it may not be wise to purchase such REITS using your SRS funds. There is also a common complaint that some REITS take back more money from unitholders via Rights Issue than the cummulative dividends that they have distributed. This would then defeat the purpose of those investors who have been relying on REITs to provide high dividends as part of their retirement funds.
Gearing ratio of a REIT refers to the sum of short-term and long term borrowings divided by the valuation of REIT’s total assets. As per MAS regulations, the maximum gearing ratio for a REIT is 45%.
Heartland Boy explains: A high gearing ratio suggests that future acquisitions made by the REIT are likely to be funded by equity. Therefore, unitholders of REIT with high gearing would have to be prepared for potential rights issue.
Weighted Debt Maturity Profile
Weighted Debt Maturity refers to the weighted average amount of time measured in years that it takes for all the debt to mature in a REIT.
Heartland Boy explains: This metric measures the re-financing risk of the REIT. A shorter weighted debt maturity profile implies that the loans will be due for repayment soon. Therefore, a REIT with a longer weighted debt maturity profile spread evenly over the years is always preferred.
Average All-In Cost Of Debt
This is the average interest cost of all the loans undertaken by the REIT.
Heartland Boy explains: Since a REIT may undertake various debt instruments overtime, the average all-in cost of debt is a useful financial metric to indicate the overall cost of the debt of the REIT. If a REIT is able to lower its average all-in cost of debt, it will be able to pass the interest expense savings to the unitholders. For instance, in its 3Q2017 results announcement, Croesus Retail Trust announced that it had lowered its cost of debt from 1.9% to 1.68%.
In the near future, Heartland Boy will be looking to expand this glossary list into a downloadable PDF for easy reference. Hopefully, this simple REIT jargon guide would help you understand better REIT jargon when investing in Singapore REITs. For readers who would like to understand the REIT industry further, you may sign up for the REITS Symposium taking place on 27 May 2017 at Suntec Singapore. You can count on Heartland Boy to attend and get some interaction time with the management of the various REITs.