Is Higher REIT Yield Better? [TFC 137]

I’m like “yeah, this is a worthy discussion”. It’s been a long time since we come back into one of Singaporeans’ favourite discussion: the REIT discussion, Real Estate Investment Trusts. I suspect that Ernie made some money in NFTs (Non-Fungible Tokens), that’s why he can start to talk to me about REITs. 

There was a period of time when I asked him “why you don’t invest in the stock market?” “I don’t really have a lot of capital to be too broadly diversified”. You see, yeah? This guy had a concentrated portfolio in digital assets.

Either way, today we’re going to focus a little bit on REITs and answer this one question on how to increase their yield. So how do REITs increase their yield? Understand the relationship between dividend price and yield and then get a better idea of how do you look at REITs? Ultimately, it’s really to learn to be a better REIT picker or pick better REITs for your portfolio so welcome back.

Good morning, everyone! I welcome you to another day with The Financial Coconut. In our podcast, we’ll be debunking financial myths, discovering best financial practices and discussing financial strategies that fits our unique life. You get it, ultimately empowering us to create a life we love while managing our finances well.

Today, we’re going to focus a little bit on how can REITs increase their yields, like “increase their yield” and how do you play this game?

Okay so I think… A little bit of clarity here first. There are a few terms that we’re going to use. Number one is REIT yield. Some people will use distribution yield accordingly so REIT yield, and the formula for REIT yield is: dividend payout or distribution payout divided by the price of the REIT. So distribution per unit divided by the price per unit of the REIT is the REIT yield. (I) repeat, the formula is: REIT yield equals distribution per unit divided by price per REIT. 

So now you see the relationship. Distribution per unit is just a term that REITs use. I would say… you want to see (it) as dividend payout, I think it’s fine. (It) doesn’t really matter. It’s just technical formula, that kind of jargons kind of stuff. They have a different word for REITs as compared to a company paying out dividends. For REITs, every time they pay out something, it is called distribution per unit. This formula is extremely important because that underpins the whole discussion of how do you increase yield?

You got to look at the formula. When the formula is as such, you can always change either (the) distribution per unit or you can change the price of the REIT and then, that will change the REIT yield essentially. When people look at REITs, they’ll be like, “oh, this REIT, the yield (is) not very high. 2%, 3%”, like data centres or like healthcare, the Parkway Health Group and some of these “safer REITs” or “popular REITs”, their REIT yield are all kind of low. 

Then you have all these crazy REITs’ (yield) like, 15%, 10%, like Sabana, First REIT or what have you. I don’t know what’s exactly the numbers but recently I saw… I think First REIT is going to have 15% yield. There was one going at 50% yield. 

How do you then look at this? What is it really trying to suggest? I think that’s the question to ask. Instead of seeing 10%, 5%, 8% as the profitability of the REIT, I would suggest that we should look at this yield as an indicator of how the market is trying to understand this REIT. 

In other words, the lower the REIT yield, it is the market suggesting that this REIT is good and solid. That’s why they are willing to pay a higher price for a lesser dividend. Pretty much, that’s the idea. Instead of seeing it… Okay, so work with me… Instead of seeing REIT yield as a direct reflection of the profitability of the REIT… that means it’s like, “oh, if I buy this REIT, I get 8% year-on-year, the yield… Or, I get 10% year-on-year yield”. 

Instead of seeing it that way, I want you to see it more in the direction of: if the REIT yield is lower 2, 3, 4%, it means the market is saying that this REIT is quite high quality or at least higher quality such that they are willing to pay a higher price for the same amount of dividend or for less distribution per unit. Because that is the formula: distribution per unit divided by price of REIT. Follow me? 

When I see it that way, I think it is a lot more reflective of how markets work. It’s also a lot more reflective of what underpins… why there are certain REITs that are going at 15% REIT yield. It’s like “oh, does it mean this REIT is producing very well, or does this mean that this REIT is a little bit risky, that’s why people don’t want to buy it and they’re paying a lower price?” Because based on the formula, as long as the price of the REIT come down and the distribution stays the same, the REIT yield will go up. This is something very important to look at. 

And today, I’m going to spend some time to share with you how some of these REITs then engineer a higher yield. How do you actually make money? Because if you think about it, it is no longer about the yield alone. It is about whether or not you can get good distribution per unit because that is the direct cash that comes in to you and whether or not the price of the REIT will stay strong or keep going up such that you get capital appreciation. 

Although we did say in our earlier episodes… please go and check out all the earlier REIT episodes. We did say in our earlier episodes that when you buy a REIT, very likely there’ll be limited capital appreciation because that is how REITs work. 

Just a quick recap: REITs is a situation where the property developer, after they develop their particular property, whether is it the mall, the office, hospital, what have you, they want to offload from their balance sheet. Because it is too heavy, hundreds of millions of dollars (being) stuck there in asset value, but there’s no cashflow.

So what do they do? They sell this property to a REIT that they manage. It tends to be the case in Singapore. They sell the property in their developer arm to the REIT. So now the REIT pays them maybe $100, $200, $300 million to the developer and then, the developer will take this money to go and develop more property and wait for capital appreciation in this property development.

Then once the property becomes matured and develop, they sell to the REIT. Again, the REIT continue to manage and get the kind of yield and then, the capital goes back to the property developer again. So, because they sell out… 

With this, it’s what we call capital recycling. Developer build, they sell to the REIT. The REIT gives them the cash and then the cash goes back to the developer, the developer can continue to build which is why people are very concerned about who’s the sponsor aka the developer. That is the whole flow. Please go and check out the earlier episode on “How To Upgrade Your REIT Game”. When you listen to that, you get a clearer idea of how REITs really work and how should you understand some of the incentive structure within the REIT ecosystem. 

With that in mind, we’ve got to recognize that there will be limited capital appreciation for every REIT. You don’t expect to buy the REIT and make 20, 30% every year. Maybe some of you made some money. I did make some money in the earlier days,. Last year, during the pandemic, when the REITs sold-out, I bought it in and then prices moved up. 

I got a little bit of weirder kind of… not… weird… what do you call that… weird returns, from a capital appreciation standpoint… Because under normal situation, (a) 5% capital appreciation, 6%… 10% is amazing, from a capital appreciation viewpoint for REIT.

If you think about, the REIT is supposed to be (a) matured property that’s not supposed to have much kind of capital appreciation. Of course, underlying property value and the REIT price itself, there’s still some difference because the REIT price work on the market. So listen to that episode, I don’t want to go deeper and deeper. 

But why do I go through that whole cycle? It’s because I want us to recognize that it is not about chasing REIT yield. REIT yield is only indicative of the quality of this REIT and the desire of the market to want to get this REIT. It is about focusing on dividend payout which is distribution per unit and also the price of the REIT. Is there capital appreciation? Because that’s all that matters to you. 

Today, when you buy into the REIT, how do you make money? You make money when (there is) a distribution payout to you and also when the price of the REIT moves up. Nothing to do with the yield anymore. I think this is extremely important, although my headline says “how to increase their yield”… is to pull you in. The real discussion is: how do you make money from REITs and how do you understand yield changes to then better indicate your REIT choices. 

So think about it at the core, the way you make money from owning REITs is when the REITs increase their distribution per unit, because that means they pay you more dividend per unit, and also, when the price of the REIT moves up. Whether or not the yield really changes, (it) doesn’t really matter to you. But if the yield changes a lot, it is very indicative of… The price of the REIT is very indicative of what the market is saying about this particular REIT. 

With that, brings me to point number one of how do you make more money with a REIT? Number one is: the REIT must be able to increase its PSF rental, per square foot rental. In other words, the REIT must be able to have pricing ability. All the properties under this REIT must be able to increase their rental per square foot. It’s actually in a property business, right? There are only… 

There are probably three mechanisms only. Number one is property occupancy. If the property is already at 95% occupancy or 100% occupancy, are you expecting more occupants in this property? No, it’s already maxed out. So this is number one. 

Number two is: can they increase their price per square feet? So for all the… For all the space that they’re renting out, can they increase it? If they can increase it, then (it’s) okay. There’s increase in revenue, there’s increase in rental. 

Number one is do they have more space to rent? If they have more space to rent, okay… then they can increase their rental. Number two is whether they can get more money per square foot, and then they can increase their revenue because they increased their rental. Number three is to cut costs, so economics of scale. 

These three fundamental ideas underpin every REIT business or every property business that is out there. Of course, there are other people that do property flipping, property development. It’s different. We’re just talking about rental of high quality properties. These three ideas underpin it pretty much. 

In this situation, why I say the focus is on increasing PSF rental rather than the other few because I think this is the only one that can give you consistent progress. At some point, the property may not be able to have any more space to lease out. The most… you see, the most… Do they have any more corners? They want to cut out the corridor to lease you the space… Yeah, I mean, they do… Some of the malls, they do. CapitaLand does a lot of those things, shout out to them. 

But if the properties under the REITs are not able to continuously engineer more space which is probably the reality… How to keep cutting? How to keep creating? If they are not able to consistently create more space, then the only real growth engine is their ability to keep charging more and more which is why I want us to focus on their ability to increase their PSF rental. 

If a REIT can increase their PSF rental over time, per square foot rent over time, then this REIT is very strong, underlying, right? Because that means the property is valuable, tenants are willing to do it, and yeah… It has the kind of ability to stay relevant and keep increasing their revenue bit by bit because that’s the only real growth potential, in my view. 

But when you’re reading, trying to understand some of the REITs… When you read through the investor relations papers, I have a few things that I want to caution all our listeners. Number one is anchor tenants. Whether is it the malls or whether is it your offices, or what have you, they all have anchor tenants. When there’s an anchor tenant… or even the hospitals, they’ve got anchor tenants. Like Parkway REIT, it’s an anchor tenant. 

Every time there’s an anchor tenant, the anchor tenant has quite a decent bargaining power. It impedes the ability of the REIT or the underlying property to negotiate higher PSF over time. In other words, let me give you a… just focus on the malls. In other words, we focus on the malls. NTUC, the library, the cinema, those guys take up a lot of space and spaces that people don’t want, like B2, Level 5, those kind of spaces. These guys pay about one-third (of) the rental of average retailers. 

You and me, we cannot lie to ourselves. NTUC and the cinema, they are anchor tenants. Although they take the very weird corners of the mall, having them makes a difference. People want to come to the mall because they have big supermarket. They have high quality produce and they have all those stuff. You go to the malls for that, at least in Singapore’s context. 

With that in mind, you need to recognize that if the mall is filled with the anchor tenants or even the offices is filled with anchor tenants, that means there’s this huge… Like WeWork takes up three levels, so that’s the anchor of the office. If there’s a big anchor tenant and it is dependent on the anchor tenant, there’s limited bargaining power. You will see their PSF going up very slowly relative to smaller merchants, where the mall have a lot of negotiation power or the property manager have a lot of negotiation power to push the rental price higher, higher, higher, over time.

I think this is extremely important because once you recognize that how you make money from the REIT is increase dividend payout or increase price of the REIT, (it is) not about the yield, then you need to recognize that, “oh yeah. Maybe this is extremely important because if the property can keep increasing PSF rental, then okay. I can make more money from this REIT”. 

But that brings me to point number two of how do you pick better REITs and increase your profitability and that is portfolio expansion. That means, the REIT goes out there to purchase more properties and increase their overall space so that they can lease out more. There are a lot of nuances in this point. I will come back to you after a word from our sponsor. 

I think a lot of you that are invested in the Singapore REIT market start to see the Singapore REITs buying property abroad… Australia, UK, China and what have you. So a lot of more purchases in the region. One of my favorite place in this world is Subang, in Malaysia and Mapletree Logistics buys a lot of Subang property. Shout out to them because that’s like an export hub near the Klang port. 

When you look at this reality, what does it tell you? It tells you that a lot of the REITs, they have no place to go already. They’ve got no property to buy here in Singapore. Of course, there’s no new properties going. What can they do? They have to buy abroad if they want to keep growing. This is one reality. Although I say that it is important for the REIT to expand their portfolio because of scale, but if they start expanding abroad, which you’re seeing… and some of them, they expand abroad, (it is)a bit questionable… 

But they expand abroad, you are subjected to exchange rate risk. This is important. Whether or not the political stability, the exchange rates, how do those things change, become more and more of an issue. That is something that I am concerned. I’m still figuring out. As I get more clarity, I will share more with all of you.

But like I said, in the earlier part of the podcast, for the underlying property to really make money so that the REIT can reflect its value, to increase that kind of profitability of the underlying property, there’s only three ways: have more space to rent out, increase the PSF and also reduce costs.

Whenever the REIT does expansion, they are increasing the space that they can rent out and they are also increasing their scale so that they can reduce the cost of management. This is extremely important and (it) tends to be that bigger REITs will have the kind of economies of scale, whether is it from rental arrangements or whether is it from managing so many properties. 

It’s like you have one marketing intern. The marketing intern can do marketing stuff for 10 properties, also can do for 3 (properties). You get the idea so with that scale, it makes them more profitable as a REIT itself. 

And yes, whenever the REIT announces that they want to expand their property portfolio, it can be through raising debt. They raise more money from debts, that means they borrow money, or they can be through the release of new REITs, new REIT units, so new shares of the REIT. 

Either way, this is something that is a little bit more complicated for discussion. Check out the earlier podcast that we’ve done. I think what is important is one of the REITs that I bought which is ESR-REIT, they went through quite a few cycles of expansion because essentially, they try to merge and become bigger and all that jazz. 

I think a lot of the properties that they own are okay, not the most fantastic. In my view, I think it’s under-appreciated as a REIT itself because of the kind of logistical nature of some of the things that they do, the manufacturing nature of the things that they do. Singaporeans think, “Aiyah (an expression of dismay), manufacture 没有 (don’t have) future. Logistics…” 

But we’re a port, guys. We cannot forget that fundamentally, one of our main business is the port. I think the port makes up at least 5% of our GDP (Gross Domestic Product) and then, all the extended businesses. All the processing, all the moving around, and all the repackaging and all those things, they all exist. 

I do think industrial spaces are under-appreciated and ESR has done whatever job that they have done. I think it’s pretty good. From a me-making-money (perspective), is good, right? Because there’s capital appreciation and underpinning that whole thing is because… When they were trying to expand their inventory, they had to sell more shares, they had to raise more debt and people didn’t believe in them so their yield went up because the price came down. 

But I went in and then the price came back down, now the yield came down. You see the relationship, right? Yield, dividend, or distribution and price. This is the relationship that you need to recognize. In this view, ultimately, the core is still: more dividend, increased price. That is the way you make money, not so much about the yield. 

Point number three on how the REIT “increase their yield”? That is: the REIT becomes the new hot sector. Like I said, in this podcast, I want to establish this clarity of the REIT yield. In the beginning, I already said that the REIT yield really is a reflection of how popular the properties are or how popular this REIT is.

So 5%, 4%, 3%, the real sense is the lower the percent, the more the price people are willing to pay per dividend for the REIT. With that clarity, REITs that are hotter, people are willing to pay a premium for it. When people pay a premium for it, the yield will come down. Because the denominator is the price of the REIT, the yield will come down.

So does it really indicate that the property has changed? Yes or no. The underlying property may stay the same, but now maybe it’s like the sectorial shift, like what is happening with the market now, with the whole tourism opening up and all that. So the reopening play, maybe that tourism will pick up and with that, tourism-related REITs become the hot sector.

When it becomes the hot sector, the yield will come down but does it mean that the underlying property has any changes? No. Okay, maybe there’ll be more rental, more people will come in and all that but has it already happened? Not yet. It’s a lot of market pricing, its expectation into the REIT yield itself.

If you think about it, data centre REITs has been in the discussion for the longest time. The REIT yield has been staying for very, very low, all in this idea that data centre is the future, the REIT future, blah, blah, blah. But from someone that has worked in the space, I would say, there are some fundamental changes that are happening within the data centre space.

A lot of the bigger guys have offloaded and tried to merge. I’ve talked to you about Equinix before. I think Equinix has a bigger portfolio mix of properties in the data centre space. They’re more consolidated. They have a lot of cables that they connect direct to Equinix that makes data transfer a lot faster and all that jazz.

What is important is Keppel DC (Data Centre) does not have that skill. Some people I know they will say, “oh you know, it’s not about that”, blah, blah, blah. But in my view, Keppel DC is trading at a super, super low REIT yield. The yield is about two point something, 3%. That is essentially the market saying, “this is a very, very good REIT. It’s here to stay for a very long time. It’s going to be like that”. 

My question is is it really going to be like that for a very long time or what is going to change? Is it going to be a situation where data centre have no more pricing power? They cannot keep increasing their PSF or is the REIT going to then be repriced as a result of new reality, new changes in technology? Don’t be too certain that data centres are here to stay forever because that is what the rental yield or the REIT yield in particular is trying to tell you in the market. 

With that, I want to once again wrap up to help all of us recognize that the yield of the REIT may or may not be indicative of how good the REIT is. It is just indicative of what the market perceives of this REIT because the formula is: REIT yield equals to dividend payout or distribution payout divided by price per REIT. With that, I hope you have a little bit more clarity of how do you then look at the REIT. How do they actually play around with the yield and how can you profit from this whole process.

With that, I’m going to sum up the three points for today of how do you better play this REIT game and understand this yield thing. Number one is the underlying property must be able to increase their PSF, price per square foot. That means their rental ability. How much can they flex? If they’ve very big anchor tenants, it means that underlying ability to keep raising rental prices may not be that strong. To me, this is one of the biggest growth engine, or I will say the only real growth engine of any REIT property because capital appreciation is already a max for the underlying property. If you want your REITs to go up, you want them… A higher payout, higher dividend and all that, then increased PSF needs to happen and this would fundamentally change REIT yields. 

Number two is portfolio expansion. If there’s more properties within this REIT then yeah, they have economics of scale and they have essentially more spaces to rent out. So I think this is extremely important. But every time a REIT announces that they want to merge or they want to release more REIT equity or they want to raise more money, it always shifts the yield. 

When it shifts the yield, what does it tell you? It only tells you market sentiments. How is the market looking at this move and not so much the underlying assets that they are buying and not so much about the profitability going forward. So always recognize this as market signal, but what you (are) trying to do is try to understand the underlying property. To me, I’m a more fundamentalist person. 

Point number three is: the REIT becomes the hot sector. Whenever the REIT becomes the hot sector, the rental… The REIT yield will change, but the fundamentals of the property may or may not have changed. It’s just a perception of a potential rise, things are coming back and all that jazz. So it becomes the hot sector. 

Of course, the converse is true. If today, data centres… There’s a new technology to say that, “oh, we no longer need something like that” or what have you, then Keppel DC REIT yield is going to move up, right? Because the market will say, “oh, you know, maybe we don’t really want this data centre anymore”, blah, blah, blah. Recognize the relationship between REIT yield, distribution per unit and price per REIT. 

I hope you learnt something useful today. See ya.

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Okay… That’s four weeks of stock-related, investment-related, kind of content. I’m going to take a break from that. But if you have any specific companies or specific funds, specific stocks that you want us to talk a little bit more about… That you feel needs to be expanded, hey, you can always drop into the Telegram group and just let me know. Let us know that “hey, there’s this thing I want to talk about. I want to look at”. 

A lot of these things, they do help. Trust me. All the questions that you ask, the things that you put up, the opinions that you throw in the Telegram group and all these things, they help to create content. So you want to be active in this process of creating content together with us, you should always do that. 

But yes, enough of the whole stock investing thing for a while. Next week, I want to talk a little bit about prudence, frugality. I think frugality has been held as a moral high ground for a very long time. Anybody that is seen as not frugal, is seen as like lesser [indiscernible].

I want to talk a little bit about that. I think any time, something is held as a moral high ground, it becomes overly simplified and on some level, problematic. So I’m going to talk a little bit about frugality and expand to you how I look at frugality and where is my position on this idea which is very prevalent in the personal finance space.

So I’ll see you next week.