Investors, growing with REITs

2022-07-30 0 By

Most investors invest in REITs for a consistent and stable income because REITs pay a quarterly or semiannual dividend.The US has the most developed REITs market, and some even pay a monthly dividend.In addition, investors expect their REITs to increase dividends per share over time.The growth strategy of REITs depends on the type of property they own and the lease structure of the properties they hold.Office REITs typically have leases of three to 10 years, which is quite different from hotel REITs, whose average room revenue varies daily.So different types of property have different growth and acquisition strategies.In a broad sense, the growth of REITs includes endogenous growth and epitaxial growth.Endogenous Growth Endogenous growth refers to the portfolio of naturally growing REITs.The three ways of endogenous growth are rent increases, asset appreciation schemes and capital recovery.Rent increase is the most common way for REITs to develop their business through endogenous growth.Rental income from tenants constitutes the bulk of REITs’ business income.The business model of REITs is to collect rent, pay the normal running costs of running a property, and then distribute at least 90% of the income to investors as dividends.Investors should naturally seek out REITs that deal in assets that benefit landlords.In this regard, current and future supply and demand conditions and the stage of the cycle in the real estate sub-sector need to be carefully examined and understood to select high-performing REITs.The advantage of long-term tenants is that they provide a guaranteed source of income over a longer period of time, while REITs managers do not need to regularly find new tenants to replace existing tenants, which is advantageous in a downward market.Smart REITs investors should understand that a short weighted average lease maturity does not necessarily mean it is a high-risk REIT.This may be a deliberate move by the manager to maintain a short weighted average lease maturity to allow the asset to benefit during rising rent cycles, especially when industry supply-demand dynamics are on the upswing.Relatively conservative REITs investors certainly prefer REITs or assets with a longer weighted average lease maturity.The longer the weighted average lease term, the lower the yield, and vice versa.You can’t have your cake and eat it too.2 Asset Appreciation Program (AEI) An asset appreciation program usually refers to the improvement or renovation of a property.Most asset appreciation programs focus on keeping the property newer and better designed, or retrofitting the property for other types of commercial use.Many retail and industrial REITs use asset appreciation schemes to obtain greater plot ratios or upgrade industrial buildings to a higher standard.These practices are often done to achieve higher yield per square foot and upgrade the tenant mix.In some cases, entire areas where existing assets are located are completely reinvented and transformed.Buildings with a new look after major renovations are often more likely to attract quality tenants and achieve higher rent increases.Industrial REITs such as Singapore’s Takeoff Real Estate Trust and Mapletree Logistics Trust have implemented AEI almost continuously.Retail REITs such as Capitaland Commercial Singapore Trust and Star Lion Real Estate Trust also make continuous retail asset upgrades and AEI in response to changes in consumer demand and developments in specific sectors.Common AEI include adding children’s playgrounds and upgrading toilet facilities to attract children or people playing games.AEI also includes improving internal efficiency by reducing administrative costs or optimizing building floor area ratio over the long term.For the smart REITs investor, it is important to distinguish between REITs using AEI to remain competitive and prevent future rent declines, and AEI maximizing its utilization to earn higher rents.Asset enhancement can unlock the hidden potential of an existing property and can be a key long-term driver of business growth, even increasing the overall value of a property.Capital recovery Singapore REITs are increasingly favouring capital recovery programmes, in which they sell non-core assets and use the proceeds to buy new assets to improve the quality of their overall portfolio or to pursue asset appreciation programmes.In fact, Over the past decade, Singapore REITs have accounted for nearly 50 per cent of all market transactions in the property sector, and their share is still growing.REITs managers often conduct capital recovery in the name of improving their REITs portfolios, but it may actually mean different things to different subindustries.The REITs management team is taking an active role in managing its portfolio through more aggressive asset buying and selling.In fact, one important lesson learned from the global financial crisis and the COVID-19 pandemic is that high-quality assets tend to withstand tough economic conditions better than lower-quality assets.During the credit crisis, banks tended to prioritise capital over high-quality assets, while REITs with poor asset quality were often at a disadvantage in terms of loan-to-value ratios, lending rates and lending terms when renewing or making new loans.Capital recovery involves selling underperforming assets and putting money into higher-yielding or better-quality assets.It’s actually not easy to do well.Still, it can help investors test the quality of REITs managers.For investors, watching how REITs managers manage capital returns is a measure of whether they live up to their reputation.Ideally, investors want REITs to upgrade asset quality and promote long-term growth, while keeping an eye on capital market-related issues such as the cost of capital, leverage and the direction of interest rates.This is often easier said than done, and few REITs managers have achieved this level, despite being backed by an army of bankers and advisers who claim to have a better understanding of shifting financial market conditions.First, REITs must decide what to sell.On the one hand, most REITs want to sell their “worst” properties.However, the sale of the “worst” properties is most likely to result in dilution of dividends and earnings – since capitalisation rates are usually the highest, it is difficult to find suitable replacements.In addition, “worst” properties can face a wide pricing gap between what buyers bid and what sellers expect, making transactions take longer than normal, especially in a more volatile market environment.Selling a “prime” property, on the other hand, can mean missing out on its long-term growth potential.”Prime” properties also tend to have the best de-risk features in the property portfolio.The second factor to consider is tax, as the challenge of capital recovery lies in the fact that the sale of a property with capital gains can create a significant tax burden in a capital gains tax jurisdiction.REITs generally prefer to hold their assets for the long term, regardless of the continuity and quality of the net property income they provide.As a result, recovery plans are easy to announce but hard to implement because REITs lose short-term revenue when they sell assets.Therefore, unless they can replace assets quickly, their net property income, distributable income and dividend per share will be affected.REITs are also exploiting opportunities in other geographic regions through capital recovery.Asia’s largest REIT, listed in Hong Kong, expanded into China’s first-tier cities for the first time in March 2015 when it acquired Omeway Mall in Beijing for Rmb2.5bn.The mall is located in Zhongguancun, haidian district, known as “China’s Silicon Valley,” targeting young white-collar and middle class customers.Subsequently, It acquired Building 1 and 2 of Enterprise World in Shanghai in July 2015.The property contains an upscale Grade A office building, shopping mall and parking lot, and is located in the famous Huaihai Road Central Business District in Huangpu District.It hired HSBC, UBS and DTZ as advisers in July 2017 to review strategic options for the REIT.The study draws on internationally leading REITs and real estate investment peer data and covers a variety of growth style assessments.The report concludes that capital recovery remains the most effective way to sustain LCT’s growth trajectory and recommends a robust approach to expansion into China’s first-tier cities.On February 28, 2018, IT subsequently sold 17 properties with a total valuation of HK $15.5 billion to GAC for HK $23 billion, making a capital gain of HK $7.393 billion.Then, less than September, IT used the proceeds to expand in Beijing, China, buying a relatively new retail property, The Beijing Jingtong Roosevelt Square in Tongzhou district, for Rmb2.56bn.As of March 2020, mainland Chinese assets accounted for 12.3 per cent of lead Realty’s portfolio, according to its latest report.Its portfolio is now worth HK $224bn.If the REITs manager sees limited growth or supply and demand in certain areas and wants to raise capital to acquire more profitable or newer properties, to purchase properties with better weighted average lease term characteristics, or to shift from over-reliance on single-tenant properties to multi-tenant properties, the REITs manager will consider selling its properties.To benefit from capital recovery requires good marketing sense, timing and luck.However, if a REIT can repeatedly seize good market timing or luck, the manager is reading the market shrewdly.Such REITs are what smart REITs investors should be looking at.For example, Tengfei Real Estate Trust sold its Chinese asset, zhongguancun Software Park, for 760 million yuan (S $160 million) in 2016.It bought it for s $62 million just over three years ago.The ability to return nearly 160 per cent in just three years speaks volumes about the shrewdness of the REIT manager.Tengfei Then made its first purchase of logistics assets in Australia worth A $1.013 billion on September 18, 2015.When we first mentioned the REITs to investors, The shares were trading at S $2.20.In essence, The Tengfei Real Estate Trust demonstrated the manager’s ability to improve asset quality, diversify geographic risk, reduce balance sheet risk and lock in substantial capital gains in a perfect and timely manner.Such REITs are what keen REITs investors should focus on, which is why Takeoff Real Estate Trust has been one of our favorite stocks over the past 20 years.However, investors should note that if the recovered cash proceeds are not used to acquire new properties, the dividend may fall in the next financial year as the sale of assets reduces earnings.This does need to be balanced, but if executed properly, the REITs manager has proven himself to be worthy of investor trust.Extensional growth 1 acquisition REITs achieve economies of scale by implementing acquisitions that deepen or diversify revenue streams and thus can have a positive wealth effect for shareholders.Large REITs can achieve positive economies of scale through economies of scale, which can be achieved by reducing capital costs, enhancing brand image, and improving negotiating power with suppliers and tenants.However, there is no unified standard for how large a critical point is, because the effect of scale may be reduced when it is beyond the control of REITs.There is solid evidence that most REITs’ claims of improved returns when they make acquisitions are generally welcomed by investors, as both capital markets and shareholders expect higher revenues and higher net property income to translate into higher dividends per share.Although the core attribute of REITs as an investment vehicle is to achieve long-term, stable and sustained dividend growth with the lowest risk, investors clearly value the growth story of REITs more.The empirical evidence of the past two decades suggests that when responsible REITs managers make higher profits through real estate acquisitions, their shareholders benefit.Singapore REITs can use up to 10% of their asset value to develop greenfield or brownfield sites, while Japanese REITs and Hong Kong China REITs are not allowed to develop, build assets or buildings on previously undeveloped land with higher risk.Singapore REITs rarely engage in greenfield development because property development is typically left to parent companies or promoters of large property developers, and is often sold to the REITs when the property is developed.The participation of REITs in green space development has both advantages and disadvantages.A key advantage is that REITs can acquire future properties at cheaper purchase prices, especially when real estate prices are expensive and all endogenous means of growth have been nearly exhausted, greenfield development is more advantageous for REITs with high cash balances and low leverage.On the other hand, the disadvantage of greenfield development is the high risk of the project, and it takes 3 to 5 years to see the cash flow.In addition, REITs may have to purchase land, absorb construction costs, reduce dividends, or increase interest expenses because they need to borrow, and pay interest charges on development loans during the development phase.