Most often than not, people like to highlight the factors to showcase the attractiveness of an investment. Well, I believe one should look at the risks facing the investment and by understanding the risks involved, one will be able to appreciate if the investment is worth buying.
Warren Buffet two most famous advice to his shareholders are: (1) Dont lose money in investment. (2) Dont forget the first rule. For most of us who cant monitor the market properly, it is important to understand your investment so that you can sleep peacefully at night. Dont get too distracted by the noises formed in the market, as they only serve to create disillusion and fear and indirectly cause you to make irrational decision.
Back to the topic on REIT, i have identified four factors that will affect the valuation of REITs. Will attempt to briefly explain to you what each of this means and how they affect the value of the REITs independently.
1. Asset Value: Also known as Net Asset Value (NAV), the NAV of REIT is a reflection of the current market value of the property. During boom times, REIT trade at a premium over the NAV while during bearish crisis, they tend to trade at a discount. A REIT trading many times above the normal industry average of NAV will trigger some concerns about it being over-valued while a REIT trading at a discount to its NAV may either signal that the REIT is in trouble or it is a true value play.
2. Rental Income: How much a REIT can distribute every quarter will really depend on how much rental income it collects. Rental rates is a true reflection of the demand and supply of different asset types (commercial space vs retail space vs industrial space). During a financial boom, demand for office space is strong, demand outstrip supply and the rental rates climb. This is good news for investors as they can expect higher distribution rates per quarter. However, the same is true for economic downturn as one can expect rental income to fall due to falling demand. However, certain asset class are more resilient and within the asset class, certain REIT will perform better due to factors such as quality of the asset, the accessibility etc.
In short, the understand the direction of the rental rates, one will have to look at the macro environment to understand how resilient the asset class is in different economic conditions and also to factor in the conditions of supply and demand and how they will unfold over time.
3. Occupany rate: This is related to rental income too. Occupany rate reflects the amount of space that is being taken up for retail/commercial purpose for a property. The higher the occupany rate, the better it is for shareholder. However, one has to understand the intricate balance between achieving a high occupancy rate versus a higher rental income.
For instance, rental income per sq ft may be high but if occupany rate is too low, it could mean that the company is losing money due to over-valuation of its properties. Conversely, a 100% occupancy rate with a lower than average rental income may mean that property space are being under-value. For asset manager, they have to do a difficult job of balancing this two factors to optimise the value of the property being used.
4. Debt refinance: This is the make or break factor for most REITs. REIT needs financing for expansion or acquisition plan. However, such financing are usually short-term notes / credits from the bank lasting 2-3 years. After which, the asset management firm will have to source for new credit line. From the perspective of banks, they will look at a few factors to identify if the asset management firm can make its repayment.
Factors such as the value of the underlying real estate assets, the trend in property values and for the particular property type and outlook for the sector. Egs, oversupply of apartment units or growth of online retail are factors that will negatively impact the value of the REITs in these areas. Finally, the management ability and capacity to successfully operate the entire portfolio of properties and real estate will determine if the banks are willing to refinance their loans.
Thus, many a times, investors will look at REITs that have secure a new refinance plan and that they do not have any financial obligations within the next 2-3 years as a sign that the company is stable.
Thats' all for today post on REITs. Before I go, I have extracted this list of datas from an analyst reports and it is for your viewing pleasure. Enjoy.
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