Analysing REITS

[corydorus]

Why don't you use NPI and Yield to determine whether the price is reasonable ?

[gzbkel]

Until now I rely mostly on the yield (as compared to historical average) to see if the price is reasonable.
I will continue to rely on yield, but I prefer to have another metric that can take into account the limited lease on the properties.
As for NPI, I use the NPI/Revenue ratio as a gauge of efficiency, but I do not rely that much on it, since it does not take into account the borrowing cost and the cut taken by the REIT manager.

Why don't you use NPI and Yield to determine whether the price is reasonable ?

[corydorus]

Until now I rely mostly on the yield (as compared to historical average) to see if the price is reasonable.
I will continue to rely on yield, but I prefer to have another metric that can take into account the limited lease on the properties.
As for NPI, I use the NPI/Revenue ratio as a gauge of efficiency, but I do not rely that much on it, since it does not take into account the borrowing cost and the cut taken by the REIT manager.

Why don't you use NPI and Yield to determine whether the price is reasonable ?

Interest coverage may be able to do that. Will tell how much buffer we have with increasing rate or leverage risk are sustainable.

[Fish Head]

taking the entire lease term is too long. There are too many varieties that make the calculation with little meaning. Why not just take 10 year as a reference.

I use yield, interest coverage, gearing and NPI to make my decision for REITS. but also try to determinate the value qualitatively, like the population around the area, potential competition and etc.

[gzbkel]

Hi corydorus and Fish Head, thanks for the feedback.

taking the entire lease term is too long. There are too many varieties that make the calculation with little meaning. Why not just take 10 year as a reference.

I use yield, interest coverage, gearing and NPI to make my decision for REITS. but also try to determinate the value qualitatively, like the population around the area, potential competition and etc.

You have a point. But if I take only 10 years of dividend, I need to somehow estimate the value of the properties at the end of 10 years.
Not sure how I can do that

It is true that qualitative analysis is equally important.
I try to first screen the REITs using some metrics that can be mechanically calculated.
After that, I can do more qualitative study into the shortlisted REITs with favorable metrics.
Was hoping to incorporate DCF into one of the metrics, but after looking at the replies here, I think it is harder than I thought.

I mainly look at the following:
- Yield, compared to historical average
- Yield spread vs 10 year SGS, compared to historical average
- P/B, compared to historical average
- Gearing
- Interest cover
- CAGR of DPU growth
- Distribution/Revenue: If ratio is low, it means that the REIT have high costs or REIT manager takes a big cut.

Regarding gearing, all along I assumed that the lower it is, the better.
However, someone I know thinks that high gearing is an indication of the REIT's credit worthiness.
The argument is that normally REIT would want to borrow as much as possible, since that would increase DPU.
But a bank would not be willing to lend much to a weaker REIT, resulting in lower gearing.
Banks do alot of due diligence before lending, much more than the average retail investor. So a REIT with high gearing means that it has passed the banks' stringent checks.
I thought this is quite an interesting perspective.

[dzwm87]

The purpose of a conservative gearing is so that when something unexpected happened, you know the company can tide through comfortably (i.e won't bankrupt). Alternatively, there is also room to leverage up if opportunity arises.

Bankers who looked credit analysis are still humans. They are bound to make errors. Besides, law of large numbers favor them as their portfolio is diversified. They can afford to lose but is your portfolio diversified to afford the tail end risk?

Anyway, there are limits to how much a REIT net gearing.

[Boon]

Hello ValueBuddies

I am trying to apply the DCF method to valuing REITs.
Hope to know your thoughts on whether the following approach is reasonable.

For simplicity, I will assume that the REIT will hold all the properties until the end of the lease, after which the properties become valueless and the REIT gets shut down.

So, value of one share = (Cash per share) - (Debt per share) + (Distribution from REIT until property lease expires)

For the last item, I use the following the DCF formula. (Image from investopedia.com)
[Image: DCF.gif]

For the number of years (n):
Since a REIT has multiple properties, each with different number of years left in the lease, I shall use the average remaining lease, weighted by the last property valuation.

For discount rate ®:
Instead of WACC, I am thinking of using the average inflation rate in Singapore.

For CF:
I will use current annualized DPU, and assume a constant growth rate per year.
For growth rate, I check the DPU CAGR of the REIT, and use a conservation figure. For example, if the DPU CAGR is 5%, perhaps I will use 3%.

Hi "gzbkel"

Your model is :

“Value of one share = (Cash per share) - (Debt per share) + (Distribution from REIT until property lease expires)”

If the concept or underlying principle of your model is:

“Value of one share = the sum of its discounted future DPU”,

then the appropriate model to use is Dividend Discount Model (DDM),

See http://www.investopedia.com/articles/fun...041404.asp

then (Cash per share) – (Debt per share) would be irrelevant and should be discarded, unless conceptually you are thinking something else.

Quote:
Conclusion
The dividend discount model is by no means the be-all and end-all for valuation. That being said, learning about the dividend discount model does encourage thinking. It forces investors to evaluate different assumptions about growth and future prospects. If nothing else, the DDM demonstrates the underlying principle that a company is worth the sum of its discounted future cash flows. (Whether or not dividends are the correct measure of cash flow is another question.) The challenge is to make the model as applicable to reality as possible, which means using the most reliable assumptions available.
Unquote:

[Temperament]

The most reliable assumptions available still is an assumptions. What is not an assumption when investing in the market? i think nothing. Nobody is 100% in the market. Singapore being such a small market, all "bets are off" if the market crashes. So will you still be around to see more crashes? If you do , Congratulations. You have passed with flying colours. imho.

[gzbkel]

Hi Boon
I thought of applying DDM, but DDM assumes that the dividend is perpetual, which is not true for REITs due to the limited lease on most properties.
Also, I wanted a way to compensate for the high amount of debt of most REITs, which was why I added the (Cash per share) - (Debt per share) part.
I am aware that REITs do not work this way (hold properties until they expire, pay off all debts and then unwind), since they usually recycle properties and constantly raise equity for new purchases. So this formula does not reflect real life very well.

Hi "gzbkel"
Your model is :
“Value of one share = (Cash per share) - (Debt per share) + (Distribution from REIT until property lease expires)”
If the concept or underlying principle of your model is:
“Value of one share = the sum of its discounted future DPU”,
then the appropriate model to use is Dividend Discount Model (DDM),
See http://www.investopedia.com/articles/fun...041404.asp
then (Cash per share) – (Debt per share) would be irrelevant and should be discarded, unless conceptually you are thinking something else.
Quote:
Conclusion
The dividend discount model is by no means the be-all and end-all for valuation. That being said, learning about the dividend discount model does encourage thinking. It forces investors to evaluate different assumptions about growth and future prospects. If nothing else, the DDM demonstrates the underlying principle that a company is worth the sum of its discounted future cash flows. (Whether or not dividends are the correct measure of cash flow is another question.) The challenge is to make the model as applicable to reality as possible, which means using the most reliable assumptions available.
Unquote:

[gutman]

This is not about valuing Reits. But for all who are interested in Reits, there is a recent presentation by Derek Tan from DBS Group Research. Enjoy.

http://www.youtube.com/watch?v=_aH87tZVnWk