3 REITs Concept to Level up your game
In episode #54, we break down the great modern-day investment tool REIT for you. For the longest time ever, only the wealthiest amongst us can own Mega malls, Hospitals, Data Centres, and whatnot. Now we get to share those sexy properties, but is it all a beautiful fairytale? Why would big developers share with us a part of their superstar properties from around the world? Let’s dive deeper into how REITs work, why they exist, and how you can benefit from this!
Hey guys! Many people are investing and these days I get a lot of questions about investments and REITs – a super popular product. I don’t know why for some reason, perhaps it’s Asians being Asians and the underlying desire to be a landlord. And just so happens that REITs don’t really require you to take up massive loans or purchase a whole property.
Many people have shared a lot of stuff about REITS online and I’m just going to chime in on some other points that I feel are less talked about and can definitely upgrade your game in REITs. So, yeah, welcome back! Today we’re going to spend some time to talk about 3 REITs concepts that I feel will help you level up your game.
Many people talk about REITs and there are many reviews about the different REITs in Singapore. And I think Seedly, my goodness, does reviews on every single REITs out there.
So kudos to them, good job, it’s a good reference!
A lot of other publications also talk about REITs like The Fifth Person. We do propagate their courses and rightfully so, because we do believe in what they are doing. Plus we cross-check and make sure the course is good. And I think a lot of you guys have went for it and you are enjoying it so far and you learn your stuff. So that’s good stuff.
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And for all of you who want to learn step-by-step, how to evaluate every single in and out of, picking your dividend stocks, your REITs, your income stocks and what have you. You can go to the financial coconut.com/dividend to, find out more about the program that we are propagating with The Fifth Person. And also, you can head to The Fifth Person’s YouTube channel and you can search for this video called “How To Invest In REITs For Passive Income – THE 5 SECRETS”. Head over to the video to see the breakdown. How do they actually look at these ratios? Because ratios are just ratios if you have no understanding of what’s going on, which is why I always caution over-focusing on them.
So let me just share with you some other things that are not talked about as much, to level up your game in the Singapore REITs market.
- Capital Recycling
Whenever I look into something, I always try to understand their incentives structures. Amongst all the different parties in that particular tool or in that particular product. Like what’s going on in between all of them so that I get a better understanding of why they exist, what they’re trying to do and what is the incentive structure so that I make better bets and align myself with certain incentive structures.
And so, when I first got to study about REITs, one of the things that got my attention was the fact that everyone was super positive about REITs. Like REITs is this thing, that you must buy, you know, it’s just so good. And I’m like, why is it so good? If REITs were so good and so profitable, then why don’t property owners just keep the property?
Which brought me to this concept of capital recycling, essentially trying to understand why REITs even exist in the first place. So fundamentally, we’ve got to look back to the property developer.
Let’s take CapitaLand as an example – the iconic property developer in Singapore. They develop everything essentially. They bid for the land, bring in the capital, bring in the expertise and do what they need to do to build the malls. What do they do after they build the malls?
They go through a few transactions, right? Buying, selling, buying, selling. Essentially, they ride on the capital appreciation of the mall. Over time, the mall becomes capital optimized.
Okay. What does that mean? When something is capital optimized, it essentially means that there’s limited upside to its capital growth.
That means the price of the mall cannot go any higher. It’s capped already – limited. I mean, if you think about it from a piece of land, they bid on it and it and finally build a mall on top of it. So the prices go up as they go along. Which is why sometimes you see redevelopment projects. People buy a whole stretch of very old shophouses, tear it down, get a license and then they build a private condominium over in the area. So the whole value of the plot of land, plus the property, increases. Because it is no longer a row of old shabby shophouses. It is now an area of high quality condominiums.
So take that same idea back to shopping malls. They get a piece of land and then they build on top of it. Now this is a mall, not just a barren piece of land, and then the prices of this property goes up and it’s maxed out at a capital optimized level.
But of course, it is not to say that the value of the property will never go up. Sometimes it goes up in tandem with the land value or there is some refurbishment or some reevaluation or around the area other malls are sold higher, and then it goes up, you know. So it’s a lot more nuanced, but generally once the mall or once the property is being sold to the REIT, the chances of its value going up is very low already.
Let’s say in the case of Bedok Mall, for all of you who know, CapitaLand Mall Trust/ CapitaLand REITs (CMT is the ticker). They bought Bedok Mall from CapitaLand in 2015 for $780 million dollars. So what happens? The CapitaLand Mall Trust pays CapitaLand $780 million to own Bedok Mall. The $780 million goes into CapitaLand and is used to develop other properties. If you take a look at CapitaLand Mall Trust’s Annual Report for 2018. The valuation of Bedok Mall on 31st December 2018, is $784 million. So it’s about the same.
In 2015, they bought it from Capitaland at $780 million, at the end of 2018, the mall is still valued at about $780 million. This is important because when you understand this concept, you understand why REITs even exist in the first place. So, when the property is already capital optimised, the property developer no longer makes any more additional yield from capital appreciation for holding on to the property.
So, they sell to the REITs, whatever REITs that they work with, or they sponsor and cash. They then take the cash to develop other properties, while at the same time, continue to manage the property and make management fees under that REIT. I’m not propagating a conspiracy theory and saying that this whole thing is a sham and a scam. It’s not, I’m just helping you understand the different parties involved in this tool so that you make a better decision. So now that you know, what is the incentive for the property developer, the incentive of the trust, the REITs and what is your incentive, then you can better align everything.
Which is why when you buy a REIT, you can almost forget about capital appreciation. When you buy a REIT you are mostly looking at rental yield. So you need to understand the tool that you’re owning and understand why this tool exists, what is the structure behind it, who is involved? And then you can better use that tool.
Rather than just blindly looking at ratios and matrices and making your bets. I hope that by understanding the whole concept of capital recycling, you get to understand why, when people say you look at REITs, you can forget about capital growth because they usually are capital optimised.
You must look at the sponsor because depending on who is a sponsor determines what kind of property will end up in the REIT. And generally just understand why all these matrices exist. What are people looking for and get a better grasp of what you’re actually doing. If you have any other more detailed questions about specific REITs or specific sectors of REITs, definitely join our community telegram group and post your questions there. I’m sure there are a lot of people who will be happy to share their thoughts.
- Gearing Ratio can be easily manipulated
Gearing ratio is essentially total debt divided by total equities. It is just trying to measure how much debt does this REIT have relative to the size of the REIT. And why do I bring this up? A lot of the content I see online always talk about trying to find a gearing ratio that is lower, because there is a cap to the gearing ratio and rightfully so, because when you cap the gearing ratio you are essentially limiting the amount of debt that the REIT can have.
And once again, when you see this view, you start to realize why a lot of these property developers want to have their own REITs. Because when they have their own REITs, they can take on more loans and buy more of their property from their original property development company. They can unlock more cash, more capital to develop more properties! So it’s a cycle. Which is also why it is good to have caps on gearing ratio, so that companies don’t over exploit the REIT structure. I specifically bring the gearing ratio into focus because a lot of websites and blogs such as Seedly and The Fifth Person, talk about finding REITs that have a low gearing ratio. The cap is 45%, some people look at 40%, some people look at 35% as a good benchmark. It is good to find gearing ratios that are lower. Meaning that the REIT is not taking on too much debt. However, It is very easy to manipulate the gearing ratio.
Not as easy as just clapping hands and the ratio changes. But, the REIT can sell more equity, sell more of itself, to raise money. In that sense, the gearing ratio will come down because of the equation (total debt divided by total equity). Now that there is more equity, the gearing ratio will be lowered. It will seem like a healthy company as the gearing ratio is lower! In actuality, they just sold more of themselves.
It dilutes everybody, because if there are 10 properties shared amongst a hundred people, and now they sell to another hundred people. Now 10 properties are shared amongst 200 people. This is an oversimplified case, but you get the idea. Now you are sharing the properties in this REIT with more people because more equity is out there. Your dividend would be lowered.
So when I look at it, I think it is more important to understand why the company needs more money, whether it is when it’s taking on more debt or whether it is selling more equity to raise more cash. I want to know the expansion plan. I want to know what they are doing and see where they’re heading towards and how it fits into my investment palate. Rather than blindly following the gearing ratio. Specifically gearing ratio because the other stuff are quite logical as talked about by The Fifth Person, on property yield, cost of debt, price-to-book ratio (P/B Ratio), dividend yield as they are more understandable.
But the gearing ratio is a lot more on financial management when you look at it from a debt management viewpoint. So definitely look beyond the ratio, look into why the REITs is raising money. Are they prudent with their capital and are they expanding into the properties that you believe in? Do they stick to their investment thesis? Rather than blindly follow different ratios and matrices.
You cannot confuse the business that rent spaces in the property and the rental business of the property. When you buy a REIT you are essentially owning the property and the business of the property is the rent. So they rent out the space and that’s all it is.
Why I specifically want to talk about this is because I hear people telling me I should buy Keppel DC REITs because more data is going to go around plus it’s a growing field with e-commerce, so owning data centers is good.
But the reality is that you don’t understand how data centers work. It’s a lot more complex when we talk about connectivity. There are different levels of data centers, also, who owns different racks in a data center? It’s a lot more complex. Of course, I’m not saying that as whole digital businesses grow, it doesn’t affect the data center business.
It does, but it’s not a direct impact. It doesn’t mean that since everyone is going into e-commerce that the rental business of data centers will go up. There are a lot more tiers in between much like the malls. When people tell me, you should sell your mall REITs now, people are going online, no one is shopping offline anymore. It is not wrong and may affect the rental business of the mall, but it is not direct and has a lot more nuances in between.
If people don’t go to shop, the shops may close their business and stop leasing the space from the property. And then, that affects the rental yield of the property. Importantly, you need to recognize that your incentive only ends at the rental of the property. It doesn’t matter how well the business that rents the space does. For shops that close in malls, others will come in and rent.
So more importantly, I think when you look at the REITs, you need to understand that your incentive stops at the property – the rental of the property. So what you need to look at is the pricing power – how much can they consistently charge for rent? Can they keep increasing rent to align with inflation or can they keep raising the rent?
Secondly, the tenancy length of the rental agreement. Are the people that are renting the property going to be renting it for a longer period of time? Longer rentals will help them withstand the current choppy period. Recognizing that when you buy a REIT it only stops at the rental, you get a much clearer idea of what to look at when you’re analyzing different properties.
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