We had previously discussed taking a long term view on post-Brexit volatility and focusing on investing in quality companies instead.
Since Brexit, strong sponsor-backed REITs have outperformed their peers in what we described as a two speed market. CapitaLand Commercial Trust, Ascendas REIT and Mapletree Industrial Trust have seen their share price increase by 10%, 7% and 12% respectively, while Sabana REIT has dropped 5%, and Viva Industrial Trust and Cambridge Industrial Trust has seen only relatively mild increases of 1% and 2% respectively.
For those who feel that they have “missed the boat”, do not worry. We believe market volatilities will persist as global investors try to make sense of the ramifications of Brexit and there should be opportunities to pick up good REITs at an attractive entry price in the months to come.
In this article, we will discuss four key factors underpinning good quality REITs which we believe will help a REIT’s share price outperform its peers in a volatile and uncertain market.
1. Blue-chip sponsors1
REIT with strong sponsors tend to outperform REITs with weaker or no sponsors in the long run. Sponsors usually holds substantial ownership in the REIT, which provides a strong alignment of interest with investors. Large sponsor stake also helps to reduce share price volatility (more retail investors tend to increase volatility due to a shorter term view with higher trading frequency). In addition, REITs with strong sponsors will find it easier to raise financing (critical for new acquistions and refinancing existing debt) plus access to cheaper financing. For example, both Mapletree Industrial Trust and CapitaLand Commercial Trust have an average financing cost of 2.5%. Comparatively, Sabana REIT, Cambridge Industrial Trust and Viva Industrial Trust has average financing cost of 4.2%, 3.6% and 4.1% respectively.
2. Location, location, location
While this may seem obvious, it is often overlooked by investors (many investors do not spend sufficient time on due diligence by walking the ground, which is akin to buying a residential property sight unseen). Investing in a REIT is the same as investing in any property. We should, in good conscience, go back to the fundamental tenets of property investing – of which location is key. Good locations are hard to come by, and unique to every property. Important areas to look out for is proximity to transport nodes (such as train stations and bus interchange), proximity to amenities (F&B areas, supermarkets, residential areas, etc.), interconnectivity to main thoroughfares and quality of competing assets in the same vicinity. Taking JCube and Westgate Shopping Mall as an example - Westgate is located directly next to the Jurong East MRT train station while JCube is situated less than 200 meters away from the train station. While both malls are located in extremely close proximity to the same train station, the success of the malls are vastly different between the two. Westgate has much higher shopper traffic driven obviously by its closer proximity and connectivity to the train station.
3. Experienced operator
We feel that this area warrants a greater level of analysis by REIT investors. The operator of a property is particularly important for certain type of assets such as shopping malls, hotels and logistics properties. Operational efficiencies and success is a key driver of value in these type of properties (less so for offices, industrial facilities and residential units). When investing in a retail REIT, key areas of operational considerations are its tenant mix, brand positioning, and the ability (or frequency) of the asset manager to hold events or promotion to draw in the crowds. Taking (again) Westgate and JEM shopping malls as an example, both malls are located side by side, and both are next to and connected to the Jurong East MRT station. However, JEM seems to have a slight edge over Westgate in terms of shopper traffic. We believe that this is due to their mass market type tenant mix and brand profile (NTUC, Charles and Keith, Breadtalk, Delifrance) which appeals better to shoppers in Jurong (whereas Westgate has relatively more upscale tenants and brands such as Isetan, Brozeit, Calvin Klein). Presumebly, folks will also buy bread more often than dress shoes.
4. Strong balance sheet
REITs with lower gearing and large debt headroom will enable them to act quickly on available eopportunities, especially in weak markets. Larger debt headroom also imply a reduced need to raise equity from investors for an acquisition (equity raising events can be potentially dilutive for existing investors). Another often overlooked point is the amount of portfolio encumbrance2, which have an impact on (future) financing costs and ability to borrow money. For example, both Mapletree Industrial Trust and CapitaLand Commercial Trust has no encumbrance on their portfolio, providing them the financial flexibility to raise additional capital when required while on the other hand Cambridge Industrial Trust has 7 of their properties under mortgage.
As you can see, it is not difficult to identify good quality REITs. Some research and walking the ground will go a long way. As we mention in our previous post, the key is finding the right entry price for such good quality REITs, and we believe the volatile markets will provide investors the opportunity to accumulate such REITs at attractive entry prices in the months to come.