Analysing REITS

Valuation of assets under management and the amount of loan will affect the gearing. The higher the gearing increases the likelihood of a rights issue.

Whether fixed rate/variable rate will affect the sensitivity of borrowing cost which impact distribution to shareholders.

(20-03-2013, 05:56 PM)Nick Wrote: A REIT is also exposed to commercial property cycles - a decline in property valuation will lead to an increase in gearing without even adding a single cent to the total debt ! In other words, 45% gearing in a boom period will not guarantee that the gearing will remain constant in a recession. If one assumes the REIT has $100 worth of assets and $45 worth of debt, the gearing is 45%. If a recession strikes and property valuation tumbles to $90, the gearing is now 45 / 90 = 50% ! If the Trust needs to refinance loans in that period, it might be fairly difficult to do so without injecting new equity.

I remember chatting with this lady from Colliers around 1.5 years back.

1. She told me that she is taking care of valuation for properties in Colliers.
2. She performed her services for property companies as well as REITs.
3. One of the valuation methods is to take into consideration the DCFs of the property.
4. Going through her assumptions, I got the sense that the property valuation methodology is rather conservative.
5. E.g. she mentioned that they use to use a discount rate of 7% before the GFC, post-GFC, they prefer to use a 8% discount rate.
6. The property valuation report is also important to the banks who are providing the financing.
7. To sum up, I recommend that a serious REIT investor should study these property valuation reports and arrive at his own conclusion.

(20-03-2013, 08:54 PM)HitandRun Wrote:

(20-03-2013, 05:56 PM)Nick Wrote: A REIT is also exposed to commercial property cycles - a decline in property valuation will lead to an increase in gearing without even adding a single cent to the total debt ! In other words, 45% gearing in a boom period will not guarantee that the gearing will remain constant in a recession. If one assumes the REIT has $100 worth of assets and $45 worth of debt, the gearing is 45%. If a recession strikes and property valuation tumbles to $90, the gearing is now 45 / 90 = 50% ! If the Trust needs to refinance loans in that period, it might be fairly difficult to do so without injecting new equity.

I remember chatting with this lady from Colliers around 1.5 years back.

1. She told me that she is taking care of valuation for properties in Colliers.
2. She performed her services for property companies as well as REITs.
3. One of the valuation methods is to take into consideration the DCFs of the property.
4. Going through her assumptions, I got the sense that the property valuation methodology is rather conservative.
5. E.g. she mentioned that they use to use a discount rate of 7% before the GFC, post-GFC, they prefer to use a 8% discount rate.
6. The property valuation report is also important to the banks who are providing the financing.
7. To sum up, I recommend that a serious REIT investor should study these property valuation reports and arrive at his own conclusion.

I wish to caution that I am not simply painting a hypothetical situation. This actually occurred during the GFC - CapitaCommercial Trust posted a 10.15% decline in property valuation and had to announce a 1 for 1 rights issue (on the same day) priced at $0.59. The gearing originally was 39% but after the asset devaluation, it was a hefty 48%. This wasn't the only REIT which reported > 5% decline in property valuation in that period.

http://cct.listedcompany.com/newsroom/20...ED56.1.pdf [Rights Issue]

http://cct.listedcompany.com/newsroom/20...5A32.1.pdf [Asset Valuation]

(20-03-2013, 08:54 PM)HitandRun Wrote:

(20-03-2013, 05:56 PM)Nick Wrote: A REIT is also exposed to commercial property cycles - a decline in property valuation will lead to an increase in gearing without even adding a single cent to the total debt ! In other words, 45% gearing in a boom period will not guarantee that the gearing will remain constant in a recession. If one assumes the REIT has $100 worth of assets and $45 worth of debt, the gearing is 45%. If a recession strikes and property valuation tumbles to $90, the gearing is now 45 / 90 = 50% ! If the Trust needs to refinance loans in that period, it might be fairly difficult to do so without injecting new equity.

I remember chatting with this lady from Colliers around 1.5 years back.

1. She told me that she is taking care of valuation for properties in Colliers.
2. She performed her services for property companies as well as REITs.
3. One of the valuation methods is to take into consideration the DCFs of the property.
4. Going through her assumptions, I got the sense that the property valuation methodology is rather conservative.
5. E.g. she mentioned that they use to use a discount rate of 7% before the GFC, post-GFC, they prefer to use a 8% discount rate.
6. The property valuation report is also important to the banks who are providing the financing.
7. To sum up, I recommend that a serious REIT investor should study these property valuation reports and arrive at his own conclusion.

DCF for REITs?
Just wondering, the cash flow should be as constant as possible otherwise the DCF model would be not practical. For stable cash flow, my guess is retail REITs being more appropriate for this model?

Also, the property valuation reporting number should fluctuate accordingly to the gearing and interest rate? Wouldn't this affect the banks financing willingness, esp. if without a strong backer like F&N, Capland, Kepland, Mapletree, etc.

i wonder do they dcf the full lease tenure of the properties or use a 10 year dcf

(20-03-2013, 05:56 PM)Nick Wrote: A REIT is also exposed to commercial property cycles - a decline in property valuation will lead to an increase in gearing without even adding a single cent to the total debt ! In other words, 45% gearing in a boom period will not guarantee that the gearing will remain constant in a recession. If one assumes the REIT has $100 worth of assets and $45 worth of debt, the gearing is 45%. If a recession strikes and property valuation tumbles to $90, the gearing is now 45 / 90 = 50% ! If the Trust needs to refinance loans in that period, it might be fairly difficult to do so without injecting new equity.

Excellent observation.

However Areit is actually the epitome among reits in terms of capital management. It's annual net income is about $400 mil. It's total debt due in any one year is less than $400 mil and this is it's stated objective.
http://areit.listedcompany.com/misc/Inve...an2013.pdf

Hence it has the ability to completely pay off debt due in any one year if there is an emergency due to a credit crunch, without resorting to massively dilutive rights or worse, firesale of assets.

A more relevant metric to look at instead of gearing (which is also dependent on subjective valuation) is the spread of total debt (net of cash) per year vs annual net income.

(20-03-2013, 10:06 PM)swakoo Wrote: Excellent observation.

However Areit is actually the epitome among reits in terms of capital management. It's annual net income is about $400 mil. It's total debt due in any one year is less than $400 mil and this is it's stated objective.
http://areit.listedcompany.com/misc/Inve...an2013.pdf

Hence it has the ability to completely pay off debt due in any one year if there is an emergency due to a credit crunch, without resorting to massively dilutive rights or worse, firesale of assets.

A more relevant metric to look at instead of gearing (which is also dependent on subjective valuation) is the spread of total debt (net of cash) per year vs annual net income.

I agree with swakoo on looking at spread of debt. I think it is in good time and low interest rate environment where we can see who is displaying excellent long term capital management skill.

http://capitamall.listedcompany.com/news...EE14.1.pdf

Look at CMT's slide 17 and 18. Last year, CMT refinanced its debt at average tenure of 8 years. Though longer debt period implies slightly higher interest rate, i believe it will create better stability and predictability when the interest environment changes. Except for 2015, debt is well spread out. Should there be change in interest rate policy in 2015 and 2016, the company can refinance at a shorter debt tenure and hence slightly lower interest rate to fill up 2020-2022. In addition, they borrow in all sort of currency, do currency and fixed rate swap to get fixed sing dollar loan.

My Personal View is as such:

The good management is making use of low interest rate to secure long-term loan even up to 12 years (For e.g. CMT, A REIT, MLT)

The average management is making use of low interest rate to secure lower cost short-term loan which results in better short term NPI. ( many reits borrowed until 2017)

The poor management is making use of low interest rate to acquire and gear up as much as they can.

(20-03-2013, 05:56 PM)Nick Wrote: A REIT is also exposed to commercial property cycles - a decline in property valuation will lead to an increase in gearing without even adding a single cent to the total debt ! In other words, 45% gearing in a boom period will not guarantee that the gearing will remain constant in a recession. If one assumes the REIT has $100 worth of assets and $45 worth of debt, the gearing is 45%. If a recession strikes and property valuation tumbles to $90, the gearing is now 45 / 90 = 50% ! If the Trust needs to refinance loans in that period, it might be fairly difficult to do so without injecting new equity.

Gearing % is measured by debt / equity, not debt / valuation. When properties price fall, loan to asset ratio increases hence equity may be raised to repay loan so that loan to asset value ratio still satisfies loan convenants. It does not alter gearing ratio %. Correct?

Any companies with high gearing ration eg 30% would face the same challenges during economic / finance crisis when their collateral value falls and hence needs to reduce loan amount.

(20-03-2013, 11:25 PM)BeDisciplined Wrote:

(20-03-2013, 05:56 PM)Nick Wrote: A REIT is also exposed to commercial property cycles - a decline in property valuation will lead to an increase in gearing without even adding a single cent to the total debt ! In other words, 45% gearing in a boom period will not guarantee that the gearing will remain constant in a recession. If one assumes the REIT has $100 worth of assets and $45 worth of debt, the gearing is 45%. If a recession strikes and property valuation tumbles to $90, the gearing is now 45 / 90 = 50% ! If the Trust needs to refinance loans in that period, it might be fairly difficult to do so without injecting new equity.

Gearing % is measured by debt / equity, not debt / valuation. When properties price fall, loan to asset ratio increases hence equity may be raised to repay loan so that loan to asset value ratio still satisfies loan convenants. It does not alter gearing ratio %. Correct?

Any companies with high gearing ration eg 30% would face the same challenges during economic / finance crisis when their collateral value falls and hence needs to reduce loan amount.

REITs don't use Debt / Equity to measure gearing. They use Debt / Investment Properties at Market Valuation. Essentially, its the same thing - if property valuation dips, it is reflected in the P&L statement as fair value loss which causes a reduction in the Equity. Both measure should result in the same conclusion (not the same number clearly) but for convenience, REIT Managers and investors tend to use the leverage ratio to measure REIT gearing.

Good point on the spreading of loans. This is something which REIT Managers learned during the GFC. I recall A-REIT had to launch a rights issue + private placement in 1Q 2009 and their current liabilities was pretty large then. Clearly, they learned their lesson. Actually, most of the REITs that went through GFC are managing their capital pretty well now.

(Not Vested in REITs)

(19-03-2013, 11:09 PM)BeDisciplined Wrote: Reits 30% gearing is excessive....but don't people also take at least 50% mortgage loan when purchasing a house?

The ratios are indeed different but the bottomline is this - People take a 50% mortgage loan and use their cash flow (imagine paying it as rental) to pay off the interest+loan, while REITS use part of the cash flow to pay off only the interest and distribute the remaining to shareholders.