Analysing REITS

[specuvestor]

Fiat money by itself is inflationary and only existed as commonplace in past 50 years since the fall of Bretton Wood. Productivity, efficiencies and balancing the budget counters that. That's why US have the debt ceiling to preserve faith in the system though many who do not understand the purpose say it is redundant. If we invert it, is the world better off without debt ceiling or balancing budget, improved standard of living etc? It's a good thing that MMT that says debt doesn't matter never took mainstream cause it's not a game to play with our lives and livelihood, to parahrase LKY.

OTOH the truth is actually that modern Econs and Finance is just as "young" as modern non-newtonian physics of about 100 years. We have progressed in leaps and bounds in the past 100 years from a world where average mortality age was like 50. Financial planning and aging population is actually a consequence of that progress. That huge transfer of wealth will also be unprecedented just as 20% of the people own 80% of the wealth. Will it be inflationary or deflationary? As usual there is always pro and cons but on balance what is optimal going forward. That's why I agree with Buffett on estate tax as a social equaliser

[donmihaihai]

Micheal learns to rock I guess.

Money not spent on cassette or CD was then spent on say handphone and mobile plan. Or get a CRT computer plus internet plan. From CRT to LCD desktop to Laptop and nowadays laptop or smart TV plus smart phone. Telco isn't getting more money from us and oh yeah wifi. This type of deflator is great, and I call it progress while sucking more resources. We are way better off to those Micheal Learns to rock days. Now so many are travelling yearly and dine out more.

Fiat money is something I don't understand. I hear or read the attack on it. But like what I wrote in the previous para, prefer what we are enjoying now and will always say no to gold standard. Why go back to a world where only royal and rich are able to live well.

[Choon]

Interesting stuffs. Cap rate dropped along with interest rate. Eg grade A office down to 4% or lesser when interest rate was at 1 to 2% maybe in the past. If interest rate stay at 4 or 5%. What kind of cap rate is needed when interest rate stay at 5%?

Investment property value is the function of cap rate and rental

Between 2018 and 2020, while US 10-Yr Treasury yield fell by about 2 percentage points from ~3% to ~1%, HKL's cap rates were unchanged (3% for office properties and 4.5% for retail properties).

Technically, cap rates are not determined by a mathematical buildup but referenced from actual property transactions in the market.

If there are no comparable transactions in HK central business district, I am not sure that a valuer can justify/argue a change in cap rates even if risk-free rates are increasing.

[donmihaihai]

Interesting stuffs. Cap rate dropped along with interest rate. Eg grade A office down to 4% or lesser when interest rate was at 1 to 2% maybe in the past. If interest rate stay at 4 or 5%. What kind of cap rate is needed when interest rate stay at 5%?

Investment property value is the function of cap rate and rental

Between 2018 and 2020, while US 10-Yr Treasury yield fell by about 2 percentage points from ~3% to ~1%, HKL's cap rates were unchanged (3% for office properties and 4.5% for retail properties).

Technically, cap rates are not determined by a mathematical buildup but referenced from actual property transactions in the market.

If there are no comparable transactions in HK central business district, I am not sure that a valuer can justify/argue a change in cap rates even if risk-free rates are increasing.

Not sure if I know how but luckily it is their problem not mine. All I need to do is exercise a little bit of common sense. 

Reading back a 2018 article on Hong Kong Office market make so much sense now. 
Just that we are in 2023.  The Messed-Up Math of Hong Kong's Roaring Office Property Market - BNN Bloomberg

Rather than start with a very good year 2018 to social unrest and end with the first year of covid, why not take a longer look,  Cap (Yield) Rates of Real Estate in Hong Kong | by ecyY | Medium. And HKL Cap rate remain, perhaps because of reducing risk free rate that counter the increasing risk of social unrest and covid. 

Why currently, Cap rate is not following the increase in risk free risk, maybe it lagged, property transaction is not like quoted shares, people do and can sit back for a long time without buying or selling. Maybe too much are at stake here, lot of wealth are locked into property, and no one want to start the ball rolling, include valuer. 

For HKL, Cap rates actually doesn't matter that much because rental will still flow. For SREITs in general, due to regulations and due to how SREITs fit into the overall structure of the group and with an eye on the ultimate price, AUM, Cap rate matter for sure.

[weijian]

Equity fund raising is probably the no-brainer but I would think that divestments from a position of strength is better, especially for leveraged entities.

S-Reits boost balance sheets ahead of financial year end

AS 2023 draws to a close, some Singapore-listed real estate investment trusts (S-Reits) have been taking steps that will help boost their balance sheets ahead of the financial year end. Over the past week, five Reits have announced various actions, including raising equity, paring down debt, as well as asset divestments.

Active capital management has been a priority for Reit managers this year, amid heightened investor attention on gearing levels, with higher interest rates putting pressure on valuations.

While regulatory requirements allow S-Reits to have a gearing limit of 45 to 50 per cent – depending on their interest coverage ratio – managers often seek to keep gearing levels within the psychological barrier of 40 per cent that some investors have.

https://www.businesstimes.com.sg/compani...l-year-end

[CY09]

From a position of strength I would infer that is when cap rate are at the lowest which usually coincides with the trough of an interest rate cycle. However, what I have observed that is when the REITs are most active in purchase -- Elite, Keppel, KBS, Manulife, UOB capital/hampshire who were divesting properties into their child REITs.

Very few REITs do the converse in this period which is to sell their properties. As alluded by some, this could be due to how the parent company sets up the child REIT to be. Personally, I would like all REIT managers to be independent of many of its parent companies but this is hard in Singapore.

[weijian]

hi CY09,

My position of strength is coming POV of a REIT shareholder. Regardless of cap rates, if the REIT is able to divest assets at/above market valuation, that sends a signal to the market, especially strong if the REIT itself is trading at much higher discount to historical levels. Such signals may close valuation gaps and provide more confidence to all stakeholders. For leveraged entities, confidence is probably key above anything else.

As for divesting during low cap rates, we can't forget that divestment means AUM reduction (and fee reduction) for the REIT manager. So whether independent or not, no REIT manager wants to manage an asset based getting smaller on an on-going basis. Putting ourselves into their shoes, do you want your salary to get lower over time?

[ghchua]

Hi weijian/CY09,

It is not only about AUM. When you divest assets, your income drops since the property is no longer in the REIT to collect rental. That being the case, DPU will also drop correspondingly, all else being equal. So, how are you going to explain to your unitholders that your DPU is dropping? Remember that a REIT is set up in order to pay almost all of their profits out as distribution to unitholders. The name of the game is to hold minimal cash and use leverage to invest almost all their available funds into properties to generate "passive" income for unitholders.

Of course, you can say that you will top up the DPU gap with divestment gains. But how long are you going to top up the gap? Unless you can increase rentals on the rest of the properties to fill it up or else it will run out one day. So, most REITs will not divest assets in a big way, unless being forced to do so.

What CY09 had suggested will not work for most REITs. Yes, they can try to read the market and divest some properties during market high cycles, but it will not be done in a big way and in the greater scheme of things, will not move the needle much as REITs will still stay invested.

[CY09]

I see your point, this may mean that a REIT in the long run may dilute its own unitholders

During good times when the REIT is able to lever up due to high valuations, it will attempt to buy properties up to say 35% leverage on pretext of growing DPU. At this instance, the powerpoint presentations of how the purchase is accreitive makes lots of sense.

However when times are bad and valuations are cut such as now, these 35% leveraged REITs are re-valued and its leverage are close to or exceed the final regulatory hurdle of 50%. The resulting action is the need to delever using equity raising or sponsor led-loan at high rates as mentioned in the Straits Time Article.

All these could have been avoided if such REITs decide not to make any purchases. In fact sometimes, it is better not to buy then and wait till a depressed market to use its remaining leverage headroom to make good acquistions.

[ghchua]

Hi CY09,

Unfortunately, your ideal situation might not happen. Because if you don't maximize your leverage during normal days, your DPU will be lower than your peers and your units will have to trade lower in order to be on par with the trading yield for the other similar REITs in your sector. And it will be difficult for you to raise funds to do anything accretive, since your units are depressed due to your low DPU. Most likely, you are not maximizing your balance sheet and investors will not be happy.

Actually, there is already some safety buffer for 35% leveraged REITs during normal times. The interest rate environment that we are seeing for the past few years might have caught them by surprise. Who would have expected such a hawkish Fed after so many years of low interest rate environment? In fact, some investors are actually leveraging on their REIT holdings in order to derive more yield from them. This shows that some feel that cheap credit should be leveraged up more in order to generate more yield. Until the party ends......