Analysing REITS

[zerobeta]

1 question:

when valuing a business trust using DCF, do we need to subtract the present value with net debt? for REIT usually I won't do it because at least 90% of their cash flow will be distributed to unitholders... is my approach correct here?

By discounting unlevered FCF with WACC, one gets the enterprise value (EV). To get the equity value, subtract from EV, any other claims (net debt, preferred, non-controlling).

By discounting the after debt cash flow (FCFE = FCF to Equity) with cost of equity, one gets the equity value.

These apply to valuing companies, business trusts or Reits………………

Knowing the mechanics of valuation method is important, but understanding the principles, logics, rationales and underlying assumptions behind each valuation method is even more critical.

Thanks!

how about if we make some adjustments to the FCF, so that FCF = distributable income.... since REIT usually pay at least 90% of distributable income as dividends (or lets be lazy and assume they pay 100%), this means discounting their distributable income will yield the same result as discounting their future dividends (DDM method)... in using DDM we don't have to subtract with any other claims.... so the same should be applied for our "adjusted" DCF...

what do you think?

[Boon]

1 question:

when valuing a business trust using DCF, do we need to subtract the present value with net debt? for REIT usually I won't do it because at least 90% of their cash flow will be distributed to unitholders... is my approach correct here?

By discounting unlevered FCF with WACC, one gets the enterprise value (EV). To get the equity value, subtract from EV, any other claims (net debt, preferred, non-controlling).

By discounting the after debt cash flow (FCFE = FCF to Equity) with cost of equity, one gets the equity value.

These apply to valuing companies, business trusts or Reits………………

Knowing the mechanics of valuation method is important, but understanding the principles, logics, rationales and underlying assumptions behind each valuation method is even more critical.

Thanks!

how about if we make some adjustments to the FCF, so that FCF = distributable income.... since REIT usually pay at least 90% of distributable income as dividends (or lets be lazy and assume they pay 100%), this means discounting their distributable income will yield the same result as discounting their future dividends (DDM method)... in using DDM we don't have to subtract with any other claims.... so the same should be applied for our "adjusted" DCF...

what do you think?

If Reits pay out 100% of its "distributable income" i.e. all of FCF to equity being paid out to shareholders - one could also use FCFE discount model to estimate the equity value, which should yield consistent result with the DDM valuation method.

Here is a good article on "FCFE discount model versus DDM"
http://pages.stern.nyu.edu/~adamodar/pdf...ed/ch5.pdf

[zerobeta]

1 question:

when valuing a business trust using DCF, do we need to subtract the present value with net debt? for REIT usually I won't do it because at least 90% of their cash flow will be distributed to unitholders... is my approach correct here?

By discounting unlevered FCF with WACC, one gets the enterprise value (EV). To get the equity value, subtract from EV, any other claims (net debt, preferred, non-controlling).

By discounting the after debt cash flow (FCFE = FCF to Equity) with cost of equity, one gets the equity value.

These apply to valuing companies, business trusts or Reits………………

Knowing the mechanics of valuation method is important, but understanding the principles, logics, rationales and underlying assumptions behind each valuation method is even more critical.

Thanks!

how about if we make some adjustments to the FCF, so that FCF = distributable income.... since REIT usually pay at least 90% of distributable income as dividends (or lets be lazy and assume they pay 100%), this means discounting their distributable income will yield the same result as discounting their future dividends (DDM method)... in using DDM we don't have to subtract with any other claims.... so the same should be applied for our "adjusted" DCF...

what do you think?

If Reits pay out 100% of its "distributable income" i.e. all of FCF to equity being paid out to shareholders - one could also use FCFE discount model to estimate the equity value, which should yield consistent result with the DDM valuation method.

Here is a good article on "FCFE discount model versus DDM"
http://pages.stern.nyu.edu/~adamodar/pdf...ed/ch5.pdf

in that case, shall we still deduct the present value with net debt (or add net cash)?

thanks again

[soros]

I wonder if it is really necessary to analyse REITS to such accounting depths for investing by minority investors? Unless you are planning a takeover of the entire REIT company , most of the information for public investors is available in the annual accounts. ( NAV and past 5 years dividend payout record, gearing, occupancy level in various buildings and passing rent per square ft etc).

The Straits Times Newspaper issue 24 Feb 2015 carries a report on the effect of Budget changes on the 26 REITS and 6 Staples Securities . It reported :

1. Stamp duty concession for Listed S-REITS will lapse at end of March 2015.

2. The following will be extended to 31 March 2020 :

a. Tax exemption for qualifying foreign income.
b. Concessionary income tax rate for qualifying non-resident.
c. Non-individual investors and REIT GST concessions.

Does anyone know if 2b refers to withholding tax on dividends paid to non-residents ?

[piggo]

in that case, shall we still deduct the present value with net debt (or add net cash)?
thanks again

No, I don't think it's reasonable to deduct net debt from unlevered FCF for a discounted cashflow valuation.

I wonder if it is really necessary to analyse REITS to such accounting depths for investing by minority investors? Unless you are planning a takeover of the entire REIT company , most of the information for public investors is available in the annual accounts.

It gives confidence to hold during times of significant paper loss, and also a comparison to other investment opportunities out there. Of course the derived value is only as good as its underlying assumptions (i.e projected cashflow which in turn depends on occupancy, financing costs, valuation etc).

[Boon]

1 question:

when valuing a business trust using DCF, do we need to subtract the present value with net debt? for REIT usually I won't do it because at least 90% of their cash flow will be distributed to unitholders... is my approach correct here?

By discounting unlevered FCF with WACC, one gets the enterprise value (EV). To get the equity value, subtract from EV, any other claims (net debt, preferred, non-controlling).

By discounting the after debt cash flow (FCFE = FCF to Equity) with cost of equity, one gets the equity value.

These apply to valuing companies, business trusts or Reits………………

Knowing the mechanics of valuation method is important, but understanding the principles, logics, rationales and underlying assumptions behind each valuation method is even more critical.

Thanks!

how about if we make some adjustments to the FCF, so that FCF = distributable income.... since REIT usually pay at least 90% of distributable income as dividends (or lets be lazy and assume they pay 100%), this means discounting their distributable income will yield the same result as discounting their future dividends (DDM method)... in using DDM we don't have to subtract with any other claims.... so the same should be applied for our "adjusted" DCF...

what do you think?

If Reits pay out 100% of its "distributable income" i.e. all of FCF to equity being paid out to shareholders - one could also use FCFE discount model to estimate the equity value, which should yield consistent result with the DDM valuation method.

Here is a good article on "FCFE discount model versus DDM"
http://pages.stern.nyu.edu/~adamodar/pdf...ed/ch5.pdf

in that case, shall we still deduct the present value with net debt (or add net cash)?

thanks again

DDM is a special case of FCFE discounting model – the mechanics in both valuation methods are such that there is no need to subtract the net debt from the present value.

When “dividends = FCFE”, both valuation methods will yield the same value estimate.

[Boon]

in that case, shall we still deduct the present value with net debt (or add net cash)?
thanks again

No, I don't think it's reasonable to deduct net debt from unlevered FCF for a discounted cashflow valuation.

By discounting unlevered FCF with WACC (the Firm or FCFF discounting model), one gets the enterprise value (EV). To get the equity value, subtract from EV, any other claims (net debt, preferred, non-controlling).

By discounting the FCF to Equity with cost of equity (the FCFE discounting model), one gets the equity value – no need to subtract the net debt from the present value.

By discounting the “dividends” with cost of equity (the DDM valuation model), one gets the value estimate – no need to subtract the net debt from the present value

DDM is a special case of FCFE discounting model - When “dividends = FCFE”, both valuation methods will yield the same value estimate.

The key in DCF is the Discount Rate should be consistent with the cash flow being discounted – avoid mismatching cash flows and discount rates.

[Boon]

MAS Responses to Consultation Feedback on Strengthening the REITs Market

Singapore, 2 July 2015… The Monetary Authority of Singapore (MAS) has refined its proposals to strengthen the REITs market, in response to industry feedback.

2 In issuing its response to feedback on its consultation paper of 9 October 2014, MAS said that it would implement these key measures to accord REIT unitholders better protection and greater accountability while providing REIT Managers increased operational flexibility.

(a) Strengthen corporate governance. Related party transactions can be substantial and frequent in REITs, hence Managers should be held to a high corporate governance standard. As such:

Managers and their directors will be bound by a statutory duty to prioritise the interests of REIT unitholders over the interests of the Managers and their shareholders, in the event of a conflict of interest.
At least half of the Manager’s board of directors must be independent directors if unitholders do not have the right to appoint the Manager’s directors.
Managers will be required to disclose their remuneration policy and procedures in the REITs’ Annual Reports. This will (i) improve market discipline and the Managers’ accountability to the unitholders when setting the remuneration for their directors and executive officers; and (ii) help investors better understand how potential misalignment of interest has been addressed. This revised position takes into account the consultation feedback that there is no need to mandate disclosure of the remuneration of each director and key executive officer.
(b) Increase transparency of fee structure. MAS will not intervene on the structure of fees or types of fees that Managers charge, but will require them to disclose the justification for each type of fees charged. Managers will also have to explain the methodology for computing performance fees, and justify how this methodology takes into account unitholders’ long-term interests. This revised position will provide greater clarity to investors on the various types of fees charged by Managers, without being over-prescriptive on how fees should be charged.

© Allow greater operational flexibility. The development limit of a REIT will be increased from 10% to 25% of its deposited property. In addition, the leverage limit imposed on a REIT will be increased from 35% to 45% of the REIT’s total assets, but a REIT will no longer be allowed to leverage up to 60% with a credit rating. These proposed changes will provide a REIT with greater operational flexibility to rejuvenate its maturing portfolio of assets. MAS will also continue to allow stapled securities structures with a REIT component to operate without group operational limits. The REIT component will continue to be subject to existing limits.

3 MAS notes respondents’ feedback that the existing approaches of relying on (i) unitholders to initiate a review of a Manager’s appointment; and (ii) disclosure to impose market discipline on the use of income support arrangements, are broadly effective. Hence, MAS is not proposing any regulatory intervention on these arrangements. MAS would also like to clarify, following questions from some respondents, that internally managed REIT structures are allowed in Singapore.

4 The enhancements to strengthen the REIT market will be phased in to facilitate a smooth implementation by the industry. Details of the finalised positions are set out in the response to the feedback received from the public consultation, which can be found here.

5 Mr Lee Boon Ngiap, Assistant Managing Director, Capital Markets, MAS, said, “We appreciate the useful comments and suggestions received from the REIT Consultation, which attracted keen interest from the industry. The finalised positions reflect a balanced approach to enhancing safeguards for investors and unitholders while facilitating the growth of a vibrant REIT market.”

http://www.mas.gov.sg/news-and-publicati...arket.aspx

[swakoo]

Very disappointed with this MAS response to fee structure. Leaves the door open for continued use of current pegging of fees to AUM which is subject to abuse by reit managers.

SECTION 2:
ALIGNMENT OF INCENTIVES

A. FEE STRUCTURE

2.1. MAS proposed to require the performance fee payable to a REIT manager to be computed based on a methodology that meets certain principles that foster stronger alignment between a REIT manager and unitholders. MAS also invited suggestions on the possible methodologies that could be adopted to comply with
the principles.

2.2. Respondents generally agreed that in principle, a REIT manager’s fee structure should be aligned with the long-term interest of the REIT
and its unitholders. Most respondents were of the view that current disclosure in trust deeds and prospectuses is appropriate and
sufficiently effective to ensure alignment of interests. They commented that it would not be appropriate for MAS to prescribe a standard metric for fee computation, such as net asset value per unit or distributions per unit (“DPU”), as every REIT is different in terms of its business model, focus, mandate and composition.

MAS’ Response

2.3. MAS notes respondents’ agreement that the performance fee structure adopted by a REIT manager should be aligned with the long-term interests of the REIT’s unitholders. MAS will not prescribe a list of permissible fee computation methodologies as REITs vary in business models and each methodology has its merits and shortcomings. Net asset value per unit and DPU are two possible metrics that could meet the principles on performance fees. Other metrics could be used if they meet these principles.

[Nick]

Very disappointed with this MAS response to fee structure. Leaves the door open for continued use of current pegging of fees to AUM which is subject to abuse by reit managers.

SECTION 2:
ALIGNMENT OF INCENTIVES

A. FEE STRUCTURE

2.1. MAS proposed to require the performance fee payable to a REIT manager to be computed based on a methodology that meets certain principles that foster stronger alignment between a REIT manager and unitholders. MAS also invited suggestions on the possible methodologies that could be adopted to comply with
the principles.

2.2. Respondents generally agreed that in principle, a REIT manager’s fee structure should be aligned with the long-term interest of the REIT
and its unitholders. Most respondents were of the view that current disclosure in trust deeds and prospectuses is appropriate and
sufficiently effective to ensure alignment of interests. They commented that it would not be appropriate for MAS to prescribe a standard metric for fee computation, such as net asset value per unit or distributions per unit (“DPU”), as every REIT is different in terms of its business model, focus, mandate and composition.

MAS’ Response

2.3. MAS notes respondents’ agreement that the performance fee structure adopted by a REIT manager should be aligned with the long-term interests of the REIT’s unitholders. MAS will not prescribe a list of permissible fee computation methodologies as REITs vary in business models and each methodology has its merits and shortcomings. Net asset value per unit and DPU are two possible metrics that could meet the principles on performance fees. Other metrics could be used if they meet these principles.

I prefer the current proposal. Let the market decide. If the REIT Manager charges too high a fee and the performance suffers, no one would buy it. And vice versa.

Plus, I don't think there is a perfect fee structure. Any structure can be manipulated if the Manager isn't of high integrity:

Fee based on AUM = Acquire anything that is on sale = higher fees.

Fee based on DPU = Acquire anything with short land lease for higher yield = higher fees.

Fee based on NAV = Aggressively revalue buildings with lower cap rates = higher fees.

Fee based on NPI / Distributable income = Acquire anything that is on sale = higher fees.

Just look at REITs with good track record and aligned interests with unit-holders. That's the best one can do. I don't think the activist mindset works in the Asian markets.

(Not Vested in REITs)