REIT Investment Basics 2
(Menara HLA is an asset of Tower REIT)
This article is a continuaton of my earlier article on REIT analysis.
It’s been a while since I last wrote. I’ve been up to my neck with projects at work and also the new design for this website. Hope you like the new look and feel, there’ll be more goodies to come this year! OK back to REIT analysis techniques…
Management Cost
REIT mananagement is a lucrative business for the Manager. Take a look at Starhill REIT as an example. Its Trust Deed entitles the Manager to the following fees:
1. Base Fee of up to 1.0% per annum of the Gross Asset Value of the Trust
2. Performance Fee of up to 5.0% of Net Property Income
3. Acquisition Fee of 1.0% of the Acquisition Price of any property purchased
4. Divestment Fee of 0.5% of the Sale Price of any property sold
Just think about it… if you were running a RM1 billion fund, your base fee alone is RM10 million a year. That is before all the other fees which will be icing on the cake. An integrated property player will also have asset management, development management and property management activities. Add them all up and you’re in a wonderful business.
But you get the picture…. the bigger the fund, the more the Manager makes. The more acquisitions by the REIT, the more the Manager makes. This is pretty much the norm for most REITs.
But to the credit of Starhill REIT, it seems the Manager opted to take a lower fee in 2008. Its Base Fee worked out to be 0.1% of gross assets while Performance Fee was 2.0% of net property income.
So look out for how your REIT Manager charges its fees so you can get a feel for whether they are really making money for you or for themselves.
Usually I like to look at the Manager & Trustee Fees as a percentage of Total Equity. If you like this ratio, it is calculataed in our Investor Database (see below example for Starhill REIT).
Underlying earnings & PE ratio
One of the things that I find somewhat misleading is how some companies and REITs bring unrealized gains into their Net Profit.
For some reason REITs bring their Fair Value Adjustments into their Income Statement, either by choice or by legal requirement I’m not sure. In our Investor Database, unrealized gains are stated seprately and for ease of analysis, we adjust the Profit Before Tax to exclude such items. See for example Tower REIT:
So in the above example, Tower REIT actually made RM28 million in 2008 rather than the RM66 million stated.
In the Income Statement, the REITs would usually show the breakdown between Realized and Unrealized Gains. The Realized figure is the one you want - see Tower REIT’s Income Statement for example. You would do well to calculate your PE Ratio based on the Realized Profit.
The Properties
This is one of the more difficult things to analyze for non-property people like myself. For most people I believe, we wouldn’t know whether one warehouse is better than another or whether a REIT has bought a good office building or not. So personally I spend very little time looking at each property owned by the REIT.
In fact if all the financials and valuation stack up, I typically spend less than 20% of my time looking at the properties they own.
Primarly the key information I would look for is:
1. Diversification
2. Tenancy Expiry Profile
If a REIT is reasonably diversified (say it owns more than 10 properties), has a decent tenant expiry profile (eg. less than 30% of net rental income expiring within 3 years), then there shouldn’t be too much to worry about. Your risk profile would be much lower compared to owning and renting out a single link house 
If I do look at the properties in any detail, it would be from a very basic perspective. Let’s use Starhill REIT again as an example:
- Its Starhill Gallery and Lot 10 parcels comprise around 35% and 24% of its total portfolio value respectively. Clearly its exposure is in Retail Shopping Centres in KL city. Starhill Gallery has a niche position in high end retailing with competition coming from centres like KLCC and Pavillion. Going into a economic downturn, I don’t think it would not be as nice as owning a Mid Valley Megamall or 1 Utama.
- Lot 10 is widely considered to be a centre in decline. In contrast to Sungei Wang across the road, it never really defined itself well in any particular segment. I was actually quite surprised when I saw that average occupancy for the parcels owned by STAREIT was 94.5% in 2008, I actually thought it was much lower. However I do believe Lot 10 has great potential for repositioning and tenancy remix. It is just across the road from the incredible Sungei Wang. The traffic is all there for the taking, just gotta give them a good reason to come across.
By now you’d realize that I’m NOT a property guru. But would I invest in Starhill REIT? Generally the type of properties they own tap into people with big fat wallets rather than your average man-on-the-street. I’m usually biased towards bread and butter stuff but STAREIT does have some impressive assets. And it has minimal gearing. So at the right price it’s worth a punt. I guess my downside would be quite limited if I can buy it at 20% discount to NTA or 9% yield.
It did in fact touch these levels a month or two back, but my procrastination did get the better of me then.
The Morale?
Don’t get caught up in Analysis-Paralysis like me!
June 13th, 2009 at 1:20 pm
Hi,
Found your website about M-REITS. Very informative.
I’ve been accumulating STAREIT since last year and is now considering whether to buy more due to the discount from NAV.
But my concern is the lack of interest among investors in REITS, government incentive, etc. Therefore, afraid that it will lock our money and couldn’t sell over a long period.
Please give your opinion.
Thx
June 13th, 2009 at 3:12 pm
Hi Chan, glad you find it helpful. I quite like Stareit myself but with its recent run-up, I’m just waiting to see if it might pull back a little first before buying in. I’m not too worried about the lack of interest if you can hold for the longer term. Good REITs are yielding 9% plus and if you buy substantially below NAV, the risk is much lower as compared with investing in other shares. Given the gloomy economic scenario this presents a “safe haven” which I believe is under-appreciated by investors. In other words the Risk/Return equation is tilted much in your favour. As for government incentives, they have in fact done quite a bit with the tax pass-through and more recently, allowing REITs to buy properties which are under construction. But because of the low prices of most REITs currently it’s hard for them to raise equity capital. At the right time there should be another growth spurt which could take the REIT market cap to RM10 billion plus, this would make it harder for institutions not to participate.
June 13th, 2009 at 10:58 pm
Hi Larry,
Can REITS registered in M’sia buy property in other country?
Since IPO, YTL didn’t really pay much attention on STAREIT, except for the purchase of Ritz Carlton. Instead, it seems they’re more interested in buying S-REITS. Could YTL eventually merge STAREIT and Starhill Global?
Thx
June 15th, 2009 at 11:06 pm
Hi Chan, yes the SC has now allowed REITs to acquire overseas assets but I believe it is there is a ceiling cap on it. There are always conflict issues for REIT Managers who manage multiple funds and Stareit is no exception. Now that REITs can acquire properties under construction, there will also be conflict issues for Managers who are part of a property development group…. who gets to buy what within the group etc. Stareit could one day choose to merge all its assets under a single fund but not sure if they will do it so soon. Another option is to do what Westfield Group did in Australia… they effectively merged 3 giant funds (Westfield Holdings, Westfield Trust and Westfield America) by “stapling” the securities of each company/trust so that when you buy a “stapled security” you are effectively buying an interest in all 3 vehicles which have exposure in different market segments.
June 19th, 2009 at 12:47 am
Hi Larry, I wonder how come Stareit still hasn’t published its 3rd quarter report on the official website? It’s already June.
June 19th, 2009 at 11:56 am
Hi Chan, Stareit announced its 2009 Q3 results on 21/5/09. Net Profit down slightly to RM20.0 million compared to pcp of RM20.7 million. NTA of RM1.19 as at 31/3/09 meaning it’s currently trading at 31% discount to NTA. They had a huge revaluation of RM254 mil on Lot 10, Starhill Gallery and JW Marriott in the Q1. Check out Bursa Malaysia announcements page for more details.
Final distribution should be in Aug-09.
June 19th, 2009 at 3:35 pm
Larry, do you know where I can get a stock screener for the whole Bursa market? Wanna screen stocks for factors like ROE
June 19th, 2009 at 5:20 pm
I sometimes look at the table in TheEdge (I think it’s the JCE estimates) but it’s far from exhaustive and does not have ROE. Actually we’ve got the ROE data here but only for the Top 70 or so counters, there are some technical issues but if you like, will try to come up with a table format one day.
July 19th, 2009 at 12:05 am
I stumbled upon your website and I must say you belong to a rare breed of generous investors who are willing to dispense sound advice and knowledge freely. I am a serious investor too and spend most of my time and effort in managing my investments. I have read with interest your articles on REITs. It is important for potential investors to realise that REITs are best valued on the basis of yield, not NVA. NVA can be subjected to fair value adjustment in either direction. Most of all, NVA is like a cake in the sky whereas distributed income is real money. Even with high yield, say 10%, investors must realise that this yield can remain stagnant for years to come without the REIT being able to grow income for all kinds of reasons. ROE among REITs are known to be poor despite their high gearing and high payout ratios due to high management fees and high financing costs. Another business may yield 6% on dividends but can grow its earnings and dividends much more rapidly and it is NOT UNCOMMON to find that an investment in a good company at an initail DY of 6% can grow to 30% over 10 years, not counting the accompanying capital gain. It is unlikely that a REIT managing a building for income can generate this kind of return over a long period. The best thing for a REIT investor to do is to channel his income from REITs elsewhere. Never reinvest your income into the same REITs because of their low ROEs. Ho
July 20th, 2009 at 5:58 pm
Thinknotblink – that is very true, yield is only one factor to look at and REITs are never a high growth proposition. For now I quite like them coz it’s hard to even identify companies that can maintain earnings, much less grow them at double digit rates. I’ve found it good to have a combination of growth and income in my own portfolio which is currently less than 20% REITs. Thanks for your insight!
July 24th, 2009 at 3:14 pm
As a shareholder of Malaysia Reits, are the dividend received subject to income tax ?
July 25th, 2009 at 9:52 am
To Curious, REIT dividends are taxed at 10% flat for individuals and you don’t need to declare them in your tax return.
To Larry, keeping REITs in your portfolio is wise provided you have bought them at attractive yields. I have invested in REITs when their yields were as high as 13% and I knew it was quite unlikely that I could obtain the same current yield in other investments in the near future. We must realise that the high yield came about a result of low unit prices, not high growth in dividends. Reinvesting the dividends into REITs is not wise at low yields, however, due to their low returns on capital. I would look at my REIT investment like a fixed income instrument like a bond. A bond doesn’t have the inherent ability to grow its coupon, unlike the business underlying a stock. When bond prices rise, yields fall and vice-versa. So when REIT yields drop to, say, 5% a 13% initial yield will have meant that the REIT unit price has risen by 160%. That’s the time to sell. REITs are good only as a place your excess fund while waiting for other investment opportunities to come along. In the meantime when nothing good comes, the yield will still compensate you for waiting.
July 27th, 2009 at 4:10 pm
I’ve got some ATRIUM REIT held through a company… I was pleased to learn that the recent distribution went through without any witholding tax deduction at all! According to the Distribution Slip:
- Resident & Non Resident Individuals/Institutions: Witholding Tax 10%
- Resident Corporates: No Witholding Tax, tax flow through
- Non Resident Corporates: Witholding Tax 25%
Thinknotblink – in the current low interest rate environment, I believe we are seeing some yield firming in the REIT sector in Malaysia. Yields are still 8% plus for most REITs, there should be more medium term upside in unit prices. I’m not too worried unless yields firm to around 6.5-7.0% in which case I’d be taking profits and sidelined. Also depending on an investor’s age profile, it could be good to have a higher portion of high-yield investments in the portfolio. For a retiree, capital growth should not be as crucial as having a nice income stream to enjoy life.
August 18th, 2009 at 12:27 pm
Comparing dividend distribution against net income can give you good indicator of whether a REIT company gives you more dividends or keeping more for themselves. Good one give its investors a distribution of at least 90% of their net income and they do it consistently. If you do this, you would suprise to see that they are some “good” REITs which actually could give better dividend but they had choose not to.