S-REITs 1Q19 Review

It's been an exhilarating quarter for those who kept the faith after a terrible 2018 and held onto their REITs this quarter. As explained in a prior post, falling bond yields globally have been the fuel behind the sharp S-REIT rally. The rally had little to do with the underlying fundamentals of the sector, and more of global institutional flows hunting for yield as bond yields plunged. 

Yield curve Inversion

With much ado over the US bond yield curve inversion, what does this mean for REITs? Should we sell all and run for the hills? Well, historically we know that it has been a reliable indicator of an impending recession. However, in many instances in the past, stock markets rallied on for as far as a couple of years. In the prior cycle, the 3m/10y inversion first occurred in January 2006 but the S&P 500 would run up by another 21%, before peaking in October 2007, a good 20 months later.

Looking at the current state of the global economic environment, I would interpret the yield curve inversion as an amber light, rather than a red light. It is a warning that we are entering the final phase of the business cycle, and just that. The end draws nigh, but markets are not about to fall off the cliff tomorrow. Furthermore, my view is that major central banks have become very proactive following the previous crisis.

Previously, they were more reluctant to bail out banks, which ultimately led to Lehman Brothers failing and turning a recession into a full fledged financial crisis. Taking the lessons of the previous crisis, major central banks have been very vigilant and have been acting very swiftly to support the economy with any early signs of weakness. These factors should keep markets well supported for the foreseeable future. 

Stars

Mapletree REITs have been stellar performers this year, on the back of institutional flows into the sector. The dividend yield spread above Capitaland has narrowed considerably.

REITs with Chinese assets have performed very well, which is to be expected given the various stimulus measures taken by the government to support the economy. Of the top 5 performers, 3 are with high or total exposure to Chinese assets (Sasseur REIT, Capitaland Retail China Trust and Mapletree North Asia Commercial Trust). Chinese assets have rallied this year as the government has eased banking lending standards, reduced the effective income tax and started spending on infrastructure projects. This has eased fears of an imminent recession and will support the REITs with Chinese assets, as described in my earlier post. Should a trade deal with the US be reached, this will be an additional cherry on top for the sector.

Laggards

Industrials as a sector continue to underperform as recession fears and falling rents act as headwinds. I would avoid this sector until the demand-supply dynamics of industrial space turns positive. This could be a couple of years away as excess supply has to be fully absorbed. However, if a global recession hits by then, this timeline could be further delayed.

Notably, the two REITs linked to Lippo Karawaci (First REIT and Lippo Malls Retail Trust) have underperformed the sector despite their relatively high yields. Their ties to troubled parent Lippo Karawaci has weighed on their performance. First REIT is one of the worst performers as the market realized that it is less of a healthcare play than initially perceived. This is because >80% rental income from the underlying hospitals were paid directly by Lippo Karawaci, rather than from the operator of the hospitals, PT Siloam International Hospitals Tbk.

This essentially means that REIT unitholders are subject to Lippo Karawaci’s cash flow generation ability, which has been dismal over the last few years. This risk is clearly quite different from that of a hospital operator, which First REIT was painted to be. Also, the rental payments have become more burdensome for Lippo Karawaci due to the currency mismatch, given that the IDR has depreciated very considerably against the SGD since its IPO in 2007.

Where do we go from here?

Bond yields have started to rise after the sharp drop in 1Q19. This implies that the rally for the S-REIT sector is largely done here, although the correction should be a mild one. I do not expect REITs to fall back to the levels we saw in 2018, though I would certainly welcome a sell-off as a golden opportunity to accumulate good quality REITs. Aside from that, I am still bullish on REITs with Chinese assets, which remain cheap against its historical yields.

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REITs III: Exchange Rates

This is Part III of my series on REITs. Please refer to Part I and Part II.

My series on REITs will not be complete without touching on exchange rate, given the internationalisation of the SGX as a major listing hub for REITs all over the world. Even blue chip REITs which were pure-plays in the Singapore space, such as Capitaland Commercial Trust, have gone abroad in hunt of fresh assets. As such, this introduces a new risk that investors cannot afford to ignore, or even take as a trivial risk. Given that the vast majority of REITs are listed in SGD but have exposure to various currencies globally, we have to study the SGD itself. As all Singaporean investors would be acutely aware, the SGD has been on a long term uptrend against most major currencies globally.

Central Bank Policy

At present, conventional monetary policy across the world usually revolves around setting interest rates to steer growth and inflation rates. Some smaller countries prefer to outsource this task to major central banks by pegging their currencies to that of their major trading partners, e.g. Hong Kong and the petro-states of the Middle East to the USD. The downside of maintaining a rigid currency peg (known as a ‘hard peg’) is that the central bank loses all control over its domestic interest rates, and is required to have ample reserves to maintain the credibility of a peg. This is because a peg means that the central bank is playing the role of a money changer for all participants in the economy. It must be able to satisfy all demand and supply for currency at the prevailing rate. A good case study is Thailand in the 1990s, which precipitated the Asian Financial Crisis. Basically, as foreign investors sold their THB to exit the market, the central bank saw its reserves deplete as it sought to defend the peg. 

To maintain a currency peg, the Central Bank has to act as the ultimate money changer, buying and selling the local currency at the pegged rate. For example, let us assume that the Monetary Authority of Singapore (MAS) were to suddenly peg the SGD to say, 1.30 against the USD. In this scenario, MAS would buy USD from exporters, inward bound investors and tourists, in exchange for SGD. This is an easy thing to do, as MAS can just ‘print’ the additional SGD in exchange for the USD received. The SGD enters into circulation for use in the broader economy, and MAS keeps the USD received as part of its foreign reserves. This is essentially what a central bank’s foreign reserves are- a hoard of foreign currencies accumulated through the course of action of a central bank’s attempt to control its currency.

On the other hand, let us consider what happen when an importer brings goods in, or a Singaporean investor buys US stocks. That person is basically offering to sell his SGD in exchange for foreign currency in order to fund his purchase or investment. MAS will therefore dip into its reserves, take the USD out in exchange for the SGD.

In the former transaction, MAS is able to print an infinite amount of SGD when exporters or inward bound investors demand for the local currency at 1.30. However, in the latter scenario, when importers or outward bound investors want to dispose of their SGD, MAS has a finite supply of foreign reserves that it can use to meet the demand for foreign currency.

Should the selling of local currency in exchange for foreign currency overwhelm the central bank’s reserves, the central bank will be unable to defend the currency at that level, and will be force to devalue the currency. This happened to the Thai Baht (THB) in 1997, when the Central Bank, the Bank of Thailand, depleted its reserves defending its currency peg then. The government was forced to allow the THB to float as it did not have the reserves to meet the flood of THB sellers. The breaking of the currency peg led to the THB going into freefall and this was the opening chapter of the crisis that ravaged Asia.

Macroeconomic Environment of Singapore

Singapore runs a massive Current Account Surplus, as a result of its strong net exports position and high national savings rate. A high national savings rate is due to household savings and government savings (fiscal surplus). Further reading on this issue (which is rather academic) can be found here. As explained above, this implies that there is a net inflow of foreign currencies into Singapore, which allows MAS to accumulate foreign currencies if it wishes to prevent the currency from appreciating sharply.

The result of the Current Account Surplus above has translated into the chart below, which demonstrates Singapore's long term uptrend of foreign reserves. We will explore further below the relationship between the current account surplus, reserves and the SGD.

Monetary Authority of Singapore (MAS) Policy

MAS has adopted a ‘soft peg’ regiment for the SGD. The SGD is permitted to fluctuate within a narrow band against a trade-weighted basket of currencies. MAS effects it monetary policy through controlling the position of the center, slope and width of the currency band. While it does not disclose the precise nature of these details, many large banks have reversed engineered the basket. The basket generally reflects the trade partners of Singapore, with the USD, MYR and CNH constituting the bulk of the basket. The following is the currency pathway of the SGD as set by MAS over the years, with the center and bands estimated by Morgan Stanley. The black bands are the 'guard rails' that MAS permits the SGD to drift within.

MAS intervenes in a similar manner as described in the 'hard peg' scenario earlier. It buys foreign currencies in exchange for SGD when the SGD presses against the ceiling of the band, and supports the SGD by selling its foreign reserves when the currency approaches the floor. It is this process of keeping the SGD within this band, that MAS accumulates its foreign reserves. This is because as demand for SGD exceeds supply due to the strong current account surplus, this will naturally lead to an appreciation of the SGD. MAS intervenes to limit the degree of intervention by selling SGD that it 'prints', in exchange for foreign currency that becomes part of MAS' reserves.

Reading the MAS semi-annual monetary policy statements will give you an insight into how MAS steers the currency. The following is extracted from MAS’ October 2018 statement, when the central bank decided to increase the slope of the currency policy band.

14.   MAS has therefore decided to increase slightly the slope of the S$NEER policy band. The width of the policy band and the level at which it is centred will be unchanged. This measured adjustment follows the slight increase in the slope of the policy band in April 2018 from zero percent previously, and is consistent with a modest and gradual appreciation path of the S$NEER policy band that will ensure medium-term price stability.

We can easily conclude from the chart above that MAS has deliberately kept the SGD on a steady and controlled upward or appreciating pathway in the long run. Even in times of economic weakness, MAS kept the slope flat, implying that the SGD remained flat against the major currencies. Historically, MAS has kept the currency on an upward slope of 2% in times of strong economic growth, and flat or 0% during periods of economic weakness. The current slope is estimated to be 1%, or in other words, the SGD is expected to strengthen at a rate of 1% per annum against the basket of currencies.

We can see below how the SGD has generally appreciated against the major currencies globally.

The SGD has held up well against other Asian currencies as well, though the RMB stands out for holding up against the SGD. This is somewhat expected as China has been an export powerhouse and has amassed the largest foreign reserves in the world (north of USD 3 trillion as of early 2019). 

What are the implications for SREITs?

Since the SGD tends to be on an uptrend against major currencies for the vast majority of the majority of the time, REITs with exposure to foreign currencies will inevitably experience drag from a stronger SGD. The investor needs to factor this when considering a REIT with non-SGD exposure. In many cases, the growth prospects of the REIT may more than compensate the effect of the currency drag, more so in many emerging markets such as China, India and South East Asia. 

However, for REITs with Developed Market exposure, such as the US, Canada, Japan, European Union and Australia, growth prospects are more muted. The currency effect is likely to be a more significant component (either positive or negative) of total returns. As such, investors need to consider the currency drag, particularly when looking at REITs with minimal or zero rental reversion.

Hedging. While currency hedging provides some visibility in the short term, it is only delaying, not preventing the impact of currency changes. This is because the earnings are only hedged for the duration of the hedge, and when the hedges expire and have to be rolled over, the DPU will be exposed to the prevailing exchange rate. 

Summary

In the long run, it is important to keep in mind that Singapore's strong current account surplus has been the major driver of SGD strength over the decades. Should these driver remain intact for the foreseeable future, MAS will continue to ensure that the SGD appreciates in a steady and gradual manner. As a result, investing in REITs with non-SGD will inevitably result in a currency drag of 1-2% per annum in the long run. While not a major issue, this could potentially affect REITs with stagnant or minimal DPU growth, and needs to be incorporated as a factor when making investment decisions. Hedging only delays the effect of exchange rates changes, not prevent it. 

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S-REITs Jan-Feb 2019 Review

S-REITs have been on tear this year, outperforming the broader market by a wide margin. Economic and market conditions have been optimal for a REIT rally. These conditions include falling bond yields due to expectations of looser monetary policy by major central banks as compared to the last 2 years. Also, a weaker economic outlook, but not quite a recession, means that growth stocks which were in vogue over the last few years, have lost their shine. 

Instead, institutional investors have turned their attention to dividend stocks, since they anticipate lower capital gains from growth stocks. Also, appetite among global investors for Asian equities have returned in a very strong manner. These factors have been the driving force behind the stampede into S-REITs this year.

So how have S-REITs stacked up so far? 

The table below shows the total returns of the S-REIT sector for the first two months of the year. While no sub-sector has outperformed in particular, the Industrials have underperformed, despite their higher yields. This is likely due to the still-pessimistic outlook for this sub-sector, more so if economic growth worsens.

The higher beta REITs have outperformed, though they were also the most battered in the sell-off last year. In the top 10, the only REITs with a majority of assets based in Singapore is CapitaLand Commercial Trust and to a lesser extent, Keppel DC REIT. The other REITs are 100% offshore assets, with the exception of Ascendas Hospitality Trust holding a single Singaporean asset.

Also, the China plays have been stellar as a resolution on the trade war looks increasingly likely, notably Sasseur REIT (19.2%), Mapletree North Asia Commercial Trust (11.4%), CapitaRetail China Trust (11.0%) and EC World REIT (10.1%). I expect the Chinese REITs to continue to outperform should a trade deal materialise. This is largely due to aggressive monetary and fiscal policy stimulus that the government unleashed in late 2018. As government policies tend to take a few months to kick in, the Chinese economy will rebound as early as the 2nd Quarter of 2019.

Where do we go from here?

Any further rally in the REIT sector as a whole will hinge on Federal Reserve policy changes over the next few months. If the Federal Reserve does indeed pause its rate hikes for good and ends it balance sheet reduction (read 'money destruction'), we can expect bond yields to head lower once more and the S-REIT rally to resume. But for now, I believe that the rally is done, though I expect prices to move sideways, or even undergo a minor correction, pending further development from the Federal Reserve. 

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IREIT Global (SGX:UD1U) 4Q18 Review

While 4Q18 results did not spring any major surprises, I noticed several salient points regarding IREIT Global (IREIT). Please refer to my initial piece here.

Gearing continues its gradual slide on upward revaluation of assets. As per the quarterly presentation, IREIT’s upward revaluation of its buildings accounted for the reduction of gearing. This is not surprising as rising rental rates in the office market and declining capitalisation rates (cap rate) in Germany has led to higher asset values. While its high gearing levels was always cited as a concern, I believe that the current level (36%) provides the REIT with some breathing room.

Loan has been refinanced at a lower rate, though borrowing sum has increased marginally. IREIT refinanced its outstanding loan of EUR 193.5 million with an 2.0% interest rate successfully with a new loan of EUR 200.8 million with a 1.7% effective interest rate. This lower interest rates will reduce the REIT’s interest expense by EUR 456k a year, though negligible on the REIT’s DPU level (0.07 cents).

However, to me, an  interesting piece of information is the tenure of the loan, that is a 7-year loan maturing in 2026. It is somewhat unusual for a bank to offer a loan beyond the lease profile of tenants. This either speaks of the bank’s lax credit policies, or perhaps, it is comfortable with the assets of the REITs that are presumably used as collateral for the loan. Which leads me on to the next point.

Office market remains hot in Germany. Vacancy rates continue to plummet in Germany as office take-up outstrips new supply of construction. Despite the hot property market, cosntruction activity remains subdued. This is important to note as it points to the likelihood that vacancy rates will remain low in the coming years, on the back of low supply of new office buildings. This is favourable for IREIT as its leases approach expiry in 2022. Should the office market remain tight and rental rates remain on an upward trajectory, the investor need not fear a concentrated tenancy profile. In fact, as highlighted in my previous post, IREIT may be a deep value stock, as investors can expect a jump in DPU come 2022. 

 Refer to the reports from JLL and Cushman & Wakefield for research details on the health of the Germany office real estate market.

Exchange rates on a downtrend. The Euro has been on a weakening trend over the last year due to a combination of politics and weaker economic data. The dividends for 2018 was hedged at 1.63, while the EUR/SGD has been declining steadily through 2018 and currently stands at 1.54. As IREIT hedges its dividends one year in advance, this implies that the the dividends for 2019 will be converted at progressively weaker levels. For this precise reason, I am not in a hurry to buy this REIT, and intend to accumulate in periods of sharp corrections, perhaps when the price is closer to 70 cents.

Conclusion

IREIT remains a deep-value REIT although in the short term, I am concerned about the effects of the weakening Euro. I am in no hurry to add this REIT to my portfolio, though it remains on my to-buy list should this REIT experience a correction.

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REITs Part II: Interest Rates

This is the second part of my analyses of REITs. Refer to Part 1 here.

The first part deals with the components of a dividend yield, where I mentioned that the risk-free rate sets the base for a REIT's dividend yield. In this post, I will focus on this component, as it is a long term driver of REIT yields as a sector.

Brief history of interest rates. Broadly speaking, as REITs trade like junk/high yield bonds, changes in government bond yields generally drive dividend yields. Institutional investors like pension funds, insurance firms, asset management companies and even central banks, tend to perceive REITs relative to government and corporate bond yields, especially since the Global Financial Crisis of 2009. Recall that at the height of the financial crisis, the Federal Reserve brought its policy rate to an unprecedented zero percent. Even with that, lending activity remained depressed and total loans in the system fell as US households deleveraged after the property bubble burst.

While short term interest rates were close to zero, longer-term interest rates remained somewhat higher. This led the Federal Reserve to embark on a series of government bond buying sprees. This entailed the central bank going into the government bond market, and buying bonds using what was essentially digital money created out of thin air. This was known as the Quantitative Easing (QE) program.

The net result of several rounds of QE led to lower bond yields and a lot more cash in the financial system. Note that while the official interest rate (Fed Fund Rate) and the US 2-year government bond was at 0%, the 10-year and 30-year government bond yields declined steadily between 2010 and 2015. This was a direct consequence of the Federal Reserve purchasing more than USD 2 trillion of US Government bonds under its Quantitative Easing program. (technical way of saying that the Federal Reserve 'printed' USD 2 trillion and bought government bonds). Naturally, by pushing down the 10 and 30-year government bond yields, this results in lower borrowing costs for companies that are issuing long-tenure bonds and even individuals seeking mortgages.

If you thought low bond yields are already bad enough, other major economies of the developed world, namely Europe and Japan took this unconventional monetary policy to new heights, by pushing interest rates and government bond yields into negative territory. The goal of this radical monetary policy was to lower borrowing costs so as to stimulate economic activity, but the side effect was inflation of asset prices globally (primary beneficiaries were stocks and real estate).

In case you were wondering, a bond with a negative yield does not mean a negative coupon. It just means that the bondholder will eventually receive his principal upon bond maturity that is lower than his initial purchase price, with the coupons collected insufficient to compensate for that difference.

How does this tie into REITs? Institutional investors drive global markets. They run the gamut from hedge funds, family offices, banks, treasury desks of large corporations, to central banks and sovereign wealth funds. They all have varying degrees of risk appetites and investment horizons, but of interest to us are what are known as 'Liability Driven Investors' (LDIs). LDIs are basically investors that make investment decisions with the primary goal of meeting future liabilities. Classic examples of LDIs are pension funds and insurance firms, who must invest not with the primary goal of short term profits, but must generate returns to meet expected payouts in the present as well as remain solvent for the distant future.

Think about your own personal insurance policies (perhaps life, or even medical insurance) from the perspective of your insurer. Your insurance firm must be able to generate sufficient returns from its portfolio not just to meet a claim anytime between the present and decades from now, but generate profits to satisfy its own shareholders at the same time. As such, LDIs typically rely on stable but low volatility investments to meet its ongoing obligations. In the pre-crisis era, bonds constituted the bulk of an LDI's portfolio. However, zero/negative interest rates and very low bond yields have made traditional LDI asset allocation very unsuitable for obvious reasons. This has led to LDIs allocating more assets to stocks in a bid to generate better returns, and REITs have been a natural alternative to bonds owing to their relatively stable dividend yields. It is this relationship that has transformed REITs into a quasi-junk bond investment class.

The relationship between the government bond yield and REITs is more apparent in the large-cap and liquid REITs as they are most likely to be held by institutions as opposed to their counterparts that are less liquid or of smaller REITs. The chart below shows the dividend yield of CapitaLand Malls Trust (CT) and CapitaLand Commercial Trust (CCT), as compared against the yield of a 5-year Singapore Government Bond (SGB). While not perfect, there is a reasonably strong correlation between the movement of dividend yields and bond yields. For the mathematically inclined, the correlation factor between these REITs and the 5-year SGB is between 0.6-0.7. 

From the chart above, we can see that the two REITs trade at a fairly constant premium to the SGB, in what is the risk-premium that investors receive for taking on risks as described in Part 1. Here, we can see with clarity that movements in the underlying bond yields are a causative factor behind changes in the REITs' dividend yields. Bearing in mind that dividend yields are a function of DPU dividend by a REIT's unit price, dividend yields can only respond to a change in SGB yields through a change in unit price. Therefore, if bond yields were to rise sharply suddenly, dividend yields would follow suit, but only through a fall in unit price. 

It is through this mechanism that we can see why REITs tend to perform poorly in periods of rising bond yields, despite the broader stock market faring well. Likewise, falling bond yields globally since late 2018 has translated in a broad based REIT rally, simply because REIT dividend yields are falling, tracking the underlying fall in bond yields. 

So when do REITs generally perform well? The sweet spot where most REITs outperform or perform as well as regular stocks is in a 'goldilocks-like' situation of modest economic growth. In this climate of lukewarm growth and business sentiments, central banks tend to keep interest rates low and monetary conditions easy. On the other hand, strong economic growth usually means higher interest rates, such as the US in 2017-18, which led to bond yields rising and ultimately hurt REITs globally. On the other hand, recessionary economic conditions will also hurt REITs in general, as vacancy rates can be expected to rise and rental rates fall (as how certain industrial REITs were impacted in the aftermath of the crude oil price plunge in 2014). REITs with a more resilient lease structure (longer leases, defensive sectors such as healthcare) will generally perform better in this environment as bond yields will fall.

So far I have only touched on the market aspect of dividend yields and bond yields/interest rates. Bond yields also affect a REIT's fundamentals in terms of its interest expense, since all REITs are leveraged. Rising interest rates will result in lower DPU, holding all else constant. Since REITs have the ability to take out bank loans or issue bonds, rising interest rates and bond yields will generally affect their interest expense.

Also, interest rates feature heavily in the calculus of acquiring new assets. The REIT manager will have to factor in the prevailing cost of debt (interest cost) plus cost of equity, if the REIT has to raise fresh equity. Should the cost of debt and/or cost of equity be higher relative to the yield of the asset-that-is-to-be-acquired, the deal will end up to be DPU dilutive. Therefore, interest rates can and do impact the viability of new assets. Generally, a lower interest rate makes an acquisition more viable. Investors familiar with the S-REIT space would have taken note that S-REITs have been exploring aggressively in Europe over the last few years. It is also no coincidence that interest rates in the Eurozone are very low, making it viable for REIT managers to borrow in EUR and purchase yield-accretive assets there.

Therefore REITs are generally very sensitive to interest rates (more so than stocks in general) as rising interest rates will have a two-fold effect:

1. Market effect - rising bond yields means that the REIT's dividend yields are pressured to rise (higher dividend yield implies lower REIT price)
2. Fundamental effect - rising bond yields translates directly into higher interest expense (lower DPU). A lower DPU compounds the market effect described above, since if dividend yields are rising, and DPU is falling, the unit price must fall by a larger quantum. 

A simple example to demonstrate this is with a hypothetical REIT with a DPU of 6 cents and a unit price of $1.00. This translates into a dividend yield of 6.0%. Let us assume that interest rates were to rise by 0.50%, and that this hypothetical REIT's market dividend yield follows suit. The outcome are as the following:

 

Here, we can see how rising interest rates are a double-whammy for REITs. Conversely, in the same example, if interest rates were to fall by 0.50% instead, the unit price would rise to $1.09 just accounting for the immediate market effect. A higher DPU of 6.5 cents, due to lower interest expense would work out to a unit price of $1.18.



Please note that the calculations above are purely hypothetical as the Fundamental Effect depends on the REIT's debt profile. If the REIT has a debt profile of long-term fixed rate loans or bonds, the interest costs will not be impacted by short term fluctuations in interest rates. In this case, the timing of when the REIT has to roll over its debt is critical. On the other hand, a REIT with a larger exposure to floating interest rates will see greater variability in its interest expense. Clearly, the examples above assumes that the REIT's debts consist of floating rate loans and bonds (perhaps tied to the SIBOR)

Summary

Interest rates and bond yields are the tide that lifts and lowers the REITs as a sector. A REIT investor ignores the broader environment of interest rates, to the peril of his portfolio. Knowing this will help you to understand why REITs tend to sell-off even if the broader stock market is not. Or why REITs seem to participate in a stock rally at times, and at other times, remain on the sidelines.

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IREIT Global (SGX:UD1U)

Germany's office real estate has been on a roll over the last few years. Judging from its share price, IREIT Global (IREIT) was deep in slumber amidst the real estate frenzy. I will examine this much unloved and non-covered REIT, as it offers an interesting, albeit long-term value proposition. This is a reversal of my usual investment thesis, where I tend to prioritise macroeconomic factors over company specific ones. 

Summary of Investment Thesis

Strengths

1. Rental rates and book value are below market rates
2. Robust office market in Germany
3. Brexit may lead to companies relocating to Germany

Weaknesses

1. EUR is vulnerable to Europe's political turmoil
2. Tenant risk concentration

What does IREIT do?

IREIT is a pure-play office REIT consisting of five office buildings located in various cities across Germany, with the largest contributor being its Berlin Campus. The REIT was listed in 2014, and the Berlin campus was subsequently injected in 2015, with no further additions since then.

The REIT's management has changed hands in 2016, when Tikehau Capital acquired 80% of the REIT manager from the previous sponsor. The previous Sponsor who carried out the IPO is an Israeli investor into European office assets. Tikehau is a pan-European Asset manager and investor and is listed on the Euronext Paris (Bloomberg Code - TKO:FP).

Change in mandate. Subsequent to the acquisition, Tikehau announced that IREIT's mandate will be broadened to include European retail and industrial assets. However, there has been no addition to IREIT since the Berlin Campus in 2015, leaving it a pure play German office REIT at present.

Shareholders. IREIT's largest shareholder is Tong Jinquan, a Chinese tycoon, with a 55% stake at present. The stake was acquired as part of the IPO, from the previous sponsor. Tong Jinquan's stake has remained largely unchanged since the IPO. On the other hand, Tikehau has gradually increased its stake in the REIT since becoming the REIT's manager in 2017. At present, Tikehau owns 8.3% of the REIT. I view this gradual increase as an encouraging sign, as it increases the alignment of the REIT manager with that of unitholders.

Macroeconomic Outlook

Germany's inflation has been stable. IREIT's leases are generally inflation-indexed, that is periodically adjusted when cumulative inflation reaches a threshold between 5-7% for the leases. The ECB’s Governing Council adopted a quantitative definition of price stability in 1998:

"Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%."

The Governing Council clarified in 2003 that in the pursuit of price stability it aims to maintain inflation rates below, but close to, 2% over the medium term.  Inflation pressure in Germany has averaged 1.5% per annum over the last 20 years, indicating that the ECB has been able to meet its goal in the long run, at least for the German economy.

German office rental market has been running red hot over the last few years, with a robust economy generating new jobs and unemployment rate hitting record lows consistently. The steady growth of jobs and workers in the economy has resulted in office vacancy rates falling rapidly in major cities.

Interestingly, though vacancy rates have been declining steadily since 2012, rental rates started to surge from 2015 onwards. This indicates that the market tightness only set in once excess supply has been absorbed. The brightly coloured lines in the charts are the cities that are relevant to the REIT, while the grey lines are for the other major cities in Germany. Reuters has highlighted the shortage of office space in Berlin.

Brexit Catalyst. Naturally, investors will be wondering, can this spike in rental rates continue? I believe that it is possible, given that German office rental rates are much lower than that of the UK and France. A key catalyst that investors have not factored in is that a hard or messy Brexit could lead to a flood of companies seeking to relocate to mainland Europe. While France is likely to be the main beneficiary of any exodus, German cities will also be a recipient of some corporates seeking to relocate. Should this materialize, this outcome will be impetus for further increases in office rental rates.

Economic Outlook for Europe and the Euro (EUR). The economic outlook for Europe is rather bleak, given the aging population, deteriorating social cohesion and political turmoil. Events such as Brexit, while may be beneficial for IREIT, bodes poorly for the grand European project and it's single currency in the long run. In my opinion, politics beyond Germany's borders is likely the biggest threat to the long term performance of this REIT, as the EUR's existence may be called into question. As shown below, the trajectory of the EUR appears to be that of a weakening trend against the SGD since the Global Financial Crisis.

Company Analysis

Given the overwhelmingly positive backdrop of the German office market, why hasn't IREIT's unit price moved positively? My answer to this question is, investors in Singapore and Asia are still oblivious, as they remain focused on IREIT's DPU, which will remain largely flat (at least in EUR terms) until 2022 at earliest, with a periodic bump up due to inflation-adjustments.The chart below captures how monotonous the REIT's revenue and NPI have been since the Berlin Campus acquisition in 2015, with any fluctuations largely due to changes in the EUR/SGD rate.

DPU rose after 2015 following the acquisition of the Berlin Campus, but declined in 2017 as the new REIT manager, Tikehau, revised the distribution rate to 90% from 100% previously. The DPU has remained stable since then, with any changes due to fluctuations in the exchange rate. Looking forward, the DPU can be expected to decline in 2019, as the EUR weakened in 2018 against the SGD. The currency hedge is expected to roll over at a lower rate, with my estimated 2019 hedged exchange rate of 1.57, as compared to 1.63 for 2018. This is a 3.7% reduction in DPU in SGD terms.

IREIT's long lease profile. At the point of IPO in 2014, IREIT's properties have always had a long lease profile. The leases for the original properties were structured with no rental escalation, save a periodic inflation adjustment. This lease structure has left the DPU relatively stable, albeit unexciting.

The bulk of the leases will start to expire commencing 2022.

Based on the table below, we can see that the Berlin Campus, with a 40% weight in the REIT, has the widest gap between market rental rates and the present lease rate for the asset.  IREIT's leases are generally far below the average market rental rate. This presents an opportunity for a bump up in DPU in 2022-2024 as the leases are renewed at prevailing market rates.


Source: Colliers

In terms of book value, the assets are likely to be undervalued. This is because the book value of real estate are commonly valued on the basis of NPI divided by the capitalisation rate. As IREIT's NPI will be adjusted upwards when the leases are renewed, the book value of the assets should be higher. Thus, the NAV of IREIT is likely to be understated.

Although there have been concerns that the REIT is highly leveraged (Sep-18: 39.1%), given my view that the assets are undervalued, the true debt-to-asset ratio is likely lower than that of the book value. In any case, the ratio has been gradually drifting downwards from the high of 43.4% reached post-acquisition of the Berlin campus in 2015.  This gradual improvement is due to the 10% retention of distributable income, paring down of debt and gradual upward revaluation of properties as Germany's capitalisation rate has been declining amid falling interest rates.

REIT Management Fee Structure

1. Management Fee-
• Base Fee: 10% p.a. of Annual Distributable Income
• Performance Fee: 25% p.a. of the difference in DPU between a financial year and the prior year
2. Acquisition Fee - 1.0% of the value of real estate investment purchased or acquisition price 
3. Divestment Fee - 0.5% of the value of real estate or sale price 
4. Trustee Fee - 0.01% p.a. of trust property value 

The performance fee ensures that the REIT manager's and unitholders' interest are aligned since the REIT manager is incentivised to pursue DPU-accretive deals. Nevetheless, despite the change in REIT manager and broadening of the mandate in April 2017, the REIT has shown little appetite for new acquisitions.

Conclusion

IREIT is a deep-value REIT, with a potentially significant upward revision of DPU in 2022 and beyond as the leases are renewed. The primary short term risk for IREIT unitholders appears to be a weakening EUR, as DPU for 2019 will be lower than 2018. IREIT remains an excellent stock to hold if you are only looking for dividends, as any DPU growth can be expected in 2022 and beyond. The stock has been trading with a dividend yield of 7-8% over the last few years.

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REITs Part I: Decomposing Dividend Yields

This is the first part of my series in how to analyse REITs.

In this article, I will be dissecting a REIT’s dividend yield so that an investor will have a better grasp when combing through the sector. This is not a recommendation to buy or sell any REIT in particular, but is intended to broaden your perspective when looking at REITs in general.

As the factors that shape a REIT’s dividend yield appear to be poorly understood by the average investor, I will be sharing my framework of decomposing a REIT’s dividend yields into simpler blocks for investors to understand. REITs, to a large extent, trade like junk (high yield) bonds, as institutional investors approach them as such. Under this paradigm, REITs are usually valued in terms of dividend yields, unlike common stocks. While REITs are also evaluated by their Price to NAV (P/NAV), it is usually a secondary factor that comes after the dividend yield.

My framework for decomposing the dividend yield is a derivative of the model typically used to analyse a corporate bond. Corporate bonds are tradeable loans of companies, and are valued according to their yields. Broadly speaking, a bond issued by a company with stronger financials will have a lower yield as compared to a bond of a weaker company. This is also reflected in the REIT market, with ‘riskier’ REITs generally offering higher dividend yields. The dividend yield can be broken down into the following factors:

Dividend Yield = Risk-Free Rate + Sector Risk + REIT-specific Risk + Other Risks

Risk-Free Rate

This is the rate of return that an investor can get by investing into a risk-free asset. This is typically represented by the yield on a government bond, though if this is not easily accessible for the average investor, using the best-in-town interest rate for a fixed or term deposit is a reasonable substitute. For the purpose of this discussion, this is theoretically the highest annual interest rate that an investor can get without subjecting his savings to any risk of capital losses.

The risk-free rate is the baseline for all bonds and in our case, REITs. To illustrate this point with an extreme example, if one could put his money in the bank at an interest rate of 10%, it is highly unlikely that he would choose to be holding REITs that yield less than 10%. This assumes that the REIT has an operating currency that is the same as the bank deposit and assets are domestic.

What if there is a REIT that yields exactly the same as the bank's interest rate, that is 10%? Would you invest in a 10% yielding REIT or a 10% bank deposit? A rational investor would prefer the bank deposit, as holding the REIT runs the risk of capital losses. The risk-free component is actually a major driver of the REIT sector as a whole, but I will address this in the next analysis of the REIT sector as it deserves a whole piece of its own. For now, we will return back to decomposing a REIT's dividend yield.

How much higher does the REIT need to yield above the risk-free rate, in order to tempt an investor to hold it, over putting it in the bank or perhaps buying a government bond? That is a question that I will be addressing in the next part. Investors need to be compensated for bearing the risk of capital losses, and that reward is known as the risk premium, which basically explains all the other components of the REIT's dividend yield.

Sector Risk

An astute REIT investor would have over time grasped the concept that certain sectors are more 'risky', that is experience greater volatility in terms of rental income and DPU. These sectors are typically more exposed to the business cycle, and include sectors such as industrials and hospitality. In contrast, sectors such as healthcare and retail are less vulnerable to fluctuations in earnings and DPU. By this point, you can probably deduce that sectors which are more resilient and have stronger growth prospects will generally have a lower sector risk premium, and trade at lower dividend yield than 'riskier' sectors. The chart below shows the distinction between the retail REITs and the industrials.

REIT-specific Risk

This component captures the factors that distinguish one REIT from another within the same sector. Although REITs within the same sector tend to have similar dividend yields, specific factors usually drive differentiation. Factors such as sponsor, growth prospects and the quality of assets can lower or raise the yield relative to the sector. Another important factor that leads to differentiation despite two REITs having identical risk profiles is leverage. REITs that leverage up should naturally have a higher dividend yield, though this relationship is clearer in sectors that are perceived to be more risky, such as industrials, hospitality and logistics. On the other hand, Investors do not seem to demand a higher risk premium (and there higher yields) for retail and office REITs.

Other Risks

This factor encapsulates the various risks that are not covered above, and broadly includes a premium for REITs with foreign assets, foreign exchange risk, poor liquidity, among others. Some factors can constitute a fairly large risk premium, and should be allocated a risk factor on its own. One of these is the country factor, which exist due to the equity home bias factor, where investors prefer to hold stocks with assets in their home country over foreign countries, on the basis of familiarity. Also, foreign exchange risk should be priced in accordingly, given MAS' monetary policy stance of gradually appreciating the SGD in the long run.

Case Study - Capitaland Retail China Trust (CRCT)

CRCT, as a retail REIT with operations purely in China, trades at a higher yield than its counterparts with Singaporean assets, particularly those under the CapitaLand umbrella such as CapitaLand Malls Trust (CT) and CapitaLand Commercial Trust (CCT). This is likely due to its operations being in China (Foreign Market-China risk). However, when compared to the other Chinese retail REITs, it trades at a lower yield. This is due to CRCT being part of the Capitaland group, which investors have assigned a risk-reduction premium. We can therefore dice CRCT’s dividend yield up in several different ways.

The first, is to view CRCT’s dividend yield as CT’s dividend yield (CapitaLand’s Singaporean mall assets) plus a Chinese risk factor, which captures the foreign exchange risk (SGD/CNY) and foreign market risk. We then add a CRCT specific risk factor to capture other subtle differences such as different leverage levels.

CRCT = CT Dividend Yield + China Country Risk + Foreign Exchange Risk + CRCT Specific Risk

Or to fully describe it in terms of my model above, we can break down CT's dividend yield as well.

CRCT = (Risk Free Rate + SG Retail REIT Risk + CT Specific Risk) + China Country Risk + Foreign Exchange Risk + CRCT Specific Risk


Alternatively, we can also express CRCT as a Chinese retail REIT, but with a risk reduction due to its backing by CapitaLand, Asia’s largest real estate company and is majority owned by Temasek.

CRCT = Chinese Retail REIT Sector Dividend Yield - CRCT-Specific Risk (CapitaLand-backed)

Summary

By understanding how REITs are priced according to their sectors, and to one another within the same peer group, we will be better prepared to take advantage of opportunities as they come by. A high yielding REIT may look attractive on a standalone basis, but what if you could invest into a peer with a slightly lower yield, but for a much lower risk profile or higher growth prospects? The key to investing into a REIT is to know what is being priced in, and more importantly, what is not being priced in, at times. Understanding this is an important source of alpha, not just for REITs, but for all assets in general.

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Ascendas India Trust (SGX:CY6U) 4Q18 Review

This is a quarterly update to my previous write-up on Ascendas India Trust (AIT). AIT reported stellar results, even in SGD terms, considering the steep decline of the INR versus the SGD. The INR slid by 9.8% over the comparable quarter a year ago. NPI rose by 14% in INR terms, and 4% in SGD terms.

Economic Outlook

The outlook for the INR is more positive for 2019, following a turbulent year for Emerging Markets in general. India's Current Account Deficit should narrow this year, as crude oil prices have plunged. As India is a net importer of crude oil, lower oil prices strongly benefits the Indian economy and reduces its import bills. Also, other external factors such as the end of the US Federal Reserve interest rate hike cycle, will ease pressure on Emerging Market currencies. However as we will see below, AIT still managed to generate decent returns in SGD terms despite the rough year for the INR.

The Indian economy is quite insular, unlike the other major economies of Asia that are heavily dependent on exports and broader global economic growth. The country is a net importer, resulting in a persistent current account deficit. While this insularity has hampered growth in the past, this cushions the economy from the worst of a global economic slowdown. The ongoing trade war between US and China is expected to have little impact on India regardless of the outcome. In addition to that, India is Asia's fastest growing major economy, growing above 7% annually, and is expected to keep that position as China continues to slow down.

Company Analysis

In NPI terms, AIT continues to demonstrate solid growth, with the growth trajectory set to be sustained in coming years. Strong rental reversion driven by a robust Indian economy and a healthy pipeline of assets under development remain the primary growth drivers for AIT.

Quarterly dividends continue to rise, following the private placement of shares in 2018, acquisition of new assets and strong rental reversions. This is an example of a management undertaking accretive acquisitions that seem to be frankly, quite lacking in the S-REIT space as of recent years. Note that over the last few years since 2014, AIT has been able to increase its floor space and DPU consistently by raising equity and debt in the right proportions so as to not stretch the balance sheet. 

Total debt-to-asset ratio remains comfortable at 33% (statutory limit: 45%), giving the REIT headroom to grow further.

Long-term prospects secured by steady pipeline. The asset pipeline as of 31st December 2018 points to AIT's floor area rising to 20.1 million square feet from the present 12.6 million square feet. On 3rd January 2019, Ascendas-Singbridge announced the acquisition of a parcel of land in Chennai to develop a new IT park, with a potential floor space of 2.3 million square feet. This represents potential assets that could eventually be injected into AIT, boosting the pipeline to a potential 22.4 million square feet.

Acquisition of Ascendas-Singbridge by CapitaLand. AIT will come under the CapitaLand stable of REITs following the merger. As CapitaLand has no meaningful presence in India or overlap in terms of business operations with Ascendas-Singbridge in that market, I do not expect this merger to materially change AIT's business model or fundamentals.

Summary

AIT remains fundamentally solid, with the latest quarter results affirming its growth story. With the INR expected to be on a stronger footing this year, the drag on DPU growth should be lower this year. In an environment of weak or zero DPU growth for the overall SREIT sector, I expect AIT to be one of the better performers.

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Parkway Life REIT (SGX:C2PU)

I personally view Parkway Life REIT (PLife REIT) as a benchmark REIT when evaluating not just the SREIT sector, but also when looking at MREITs and HKREITs. It is one of the few healthcare REITs available in the region, and by far the best in terms of asset quality and DPU outlook. Its earnings and dividends are very stable due to the nature of its leases.

Summary of Investment Thesis

Strengths

1. DPU growth is like clockwork - NPI grows at a minimum of 0.6% per annum on average
2. Very long lease profile ensures stability- Singapore leases are on a 15+15 years basis (commencing 2007) while Japanese assets have an average lease tenure of 12.64 years
3. Strong demand for premium healthcare in the region - Singapore is a leading medical tourist hub for the region's high net worth individuals.

Risks

1. Japanese asset prices/rental rates may suffer from deflation
2. DPU may be affected in 2022-2023 when hedges related to the JPY exposure are rolled over

What does PLife REIT do?

PLife REIT holds Singapore's premium healthcare facilities, a private Hospital in Malaysia and nursing homes in Japan. Its Singaporean assets account for the bulk of revenue, followed by its stable of Japanese nursing homes. Its sole Malaysian asset contributes less than 0.4% of NPI for 2018, and I will exclude it from my analysis due to immateriality.

It's Singaporean hospitals, primarily Mount Elizabeth and Gleneagles, cater to the affluent segment of Singaporean society, expats and medical tourists from South East Asia and beyond. PLife REIT has signed a lease agreement with IHH for 15 + 15 years with effect from 23 August 2007 on a triple net lease basis. CPI + 1% rent review formula for Singapore Hospital Properties guarantees minimum 1% growth annually (CPI deemed as zero if it is negative). This arrangement ensures that the Singaporean assets have an occupancy rate of 100% and rental growth of at least 1% per annum for the entire duration of the lease period.

The operational statistics below, while bearing no direct impact on the REIT due to the triple net lease structure, points to the role of PLife REIT in its Sponsor's (IHH Healthcare Berhad) growth trajectory. Thus we can be assured that the Sponsor's business interest is aligned with the REIT, and that an eventual non-renewal of the lease by the Sponsor is highly unlikely given the importance of the REIT's assets to the Sponsor.

The Japan portfolio consist of long-term leases with weighted average lease term to expiry of 12.64 years as of September 2018. The portfolio has exposure across Japan, consisting of 1 pharmaceutical product distributing and manufacturing facility and 45 private nursing homes. PLife REIT has been gradually expanding its footprint across Japan since 2012.

Macroeconomic Outlook

Singapore

Rising affluence in South East Asia provides a growing customer base. Singapore is a healthcare hub for South East Asia, attracting medical tourists from the affluent segments of the region. The rapid growth of this segment in South East Asia as a whole provides an expanding customer base that PLife REIT is well positioned to capture. The chart below is derived from Credit Suisse's Global Wealth Report 2018 on the rise of the wealthy in Asia, which augurs well for PLife REIT in the longer run.

Benign but positive inflation outlook. As the Parkway Singapore master leases are tied to the Consumer Price Index (CPI), it is important to understand the factors that drive the CPI. Over the last few years, the overall index paints a picture of rather weak inflation and we shall take a quick peek under the hood to better understand the factors that drive inflation.

Generally, the bulk of variability in the CPI can be attributed to changes in the Housing & Utilities (yellow) and Transport (green) components. Further digging reveals that the housing & utilities component is closely correlated to rental rates while the transport component is linked to changes in the premium of a Certificate of Entitlement (COE). The other components, such as food and education form the base for a consistent source of inflation pressure of about 0.6% over the last few years, which I would deem to be a rule-of-thumb indicator of long-term core inflation.

Residential rental rates are starting to rise. Due to a reduction in expats from the traditionally well-paying financial and oil & gas sectors, this has resulted in rental rates falling across Singapore. While the actual number of foreigners have increased over the years, the composition of workers have undergone a shift, with fewer highly paid expats in the market. This has translated into gradually declining residential rental rates. As housing cost is calculated using the imputed rent method for measuring inflation, even if you are living in your own property, your housing cost is deemed to have decreased if the overall rental rates fall. As such, there is a very strong correlation between the URA Rental Index and CPI Housing & Utilities component. It appears that changes in the rental market has a much stronger impact than increases in utilities. Following the peak in 2014, the URA Rental Index has been on a steady decline but it appears to have bottomed out in 2017 and climbed modestly in 2018.

Are COE premiums bottoming out? Although COE premiums have been trending downwards over the last few years, this is largely due to the increase in COE supply due to the deregistration of existing vehicles. It appears that the deregistration of existing vehicles will fall off sharply between 2019-2020, and if no new growth of vehicles is permitted, COE premiums can be expected to start rising again in 2019. However, the impact of changes in COE premiums on the CPI Transport component has weakened since 2014, which indicates that there was probably a change of weights when the CPI Index was re-balanced in 2014.

Strange as it may sound, PLife REIT's rental reversion ultimately hinges on two totally unrelated variables- residential rental rates and COE prices. The outlook for residential rental rates appear to be on a mild uptrend, though no acceleration should be expected given the lukewarm economic climate. Meanwhile, COE premiums are likely to turn higher in 2019 due to a the expected cyclical fall in vehicle deregistration. A combination of rising rental rates and COE premiums will exert upward pressure on the CPI up for 2019 and 2020, which bodes well for PLife REIT's DPU growth over the next two years.

Japan

Aging demographics. As the most aged country in the world, Japan has a median age of 47.3. On the surface, it may seem like an unbridled positive given PLife REIT's portfolio of nursing homes in Japan, in reality it is a doubled-edged sword. Why does deflation matter? Because it exerts downward pressure on rental rates and asset prices in general. Unlike Singapore, Japan struggles with structural deflation due to its aging population that is expected to shrink at an accelerating rate.

Despite that, inflation in Japan has remained positive due to the Bank of Japan's monetary policy in the form of massive money printing, known as Quantitative and Qualitative Monetary Easing (QQE) program. While the scope of Japan's monetary policy is too complex and lengthy to be discussed here, it should be sufficient to stave off deflation in Japan for the foreseeable future, though not by a large margin. While PLife REIT's Japanese assets have downside risk protection, which protects unitholders, there is little upside for rental rates either. As of 3Q18, only 13.2% of the REIT's Japan's assets by revenue are subject to market revision while the rest are downside protected. My view is that since the Bank of Japan has been pursuing its goal of 2% inflation rate quite doggedly over the last few years through massive monetary stimulus, though with limited success. we can expect inflation to remain above 0% in the longer term.

Company Analysis

Sponsor - IHH Healthcare Berhad (IHH)

PLife REIT is backed by IHH, a leading healthcare group in South East Asia, and is dual listed on the Singapore Exchange and Bursa Malaysia. The group has recently undergone changes in terms of its largest shareholders in November 2018. The largest shareholder, Khazanah Nasional Berhad (Khazanah), Malaysia's sovereign wealth fund, sold 16.0% of its stake to the second largest shareholder, Mitsui & Co Ltd (Mitsui), a Japanese conglomerate, leading to a swap in their shareholding positions. Post-transaction, Mitsui's stake rose to 32.9% while Khazanah's shareholdings was reduced to 26.05%. I do not expect the transaction to impact PLife REIT's strategic direction, since both the companies have been long-term shareholders of IHH. This disposal is in line with the new Malaysian government's decision to pare down its stake in its major shareholdings, rather than as a statement of its view of IHH. In the same vein, Singaporean investors would have noticed that Axiata (majority owned by Khazanah) has decided to sell its stake in M1. Ultimately, what matters most to unitholders is that the Sponsor has not acted in any way that is detrimental to unitholders since its IPO in 2007.

Financials

Due to the long leases of all its assets, PLife REIT's financials are remarkably stable. The NPI breakdown shows that the Singaporean hospitals form the bedrock of the REIT, with its relentless and stable growth while the Japanese assets show some variability.

A steadily rising NPI has translated into an uptrend for DPU, though the DPU for 2015 and 2017 were bumped up by the distribution of realized capital gains upon disposal of some Japanese assets. DPU growth for the Singaporean assets are driven by the rental reversion factor of CPI + 1%. As the Singaporean assets contributes to 60% of NPI, we can expect growth for the overall NPI to rise by 60% X (CPI + 1%), leading to a minimum annual growth of 0.6% of NPI if the CPI is zero or negative. As the 'core' inflation for Singapore stemming primarily from Food and Education components discussed above has averaged 0.6% per annum, we can assume an average inflation rate of at least 0.6% in the long run. Based on this assumption, I expect the Singapore assets NPI to grow by 1.6%, and for overall NPI to rise by approximately 1.0% per annum. Likewise, DPU growth should track the underlying NPI growth. However, due to proactive management with acquisitions/disposals of various assets in Japan, this has led to DPU growth outpacing the automatic rental escalations imputed into the Singapore leases.

Comfortable and sustainable debt. Although the REIT has sizeable JPY debt, the management has utilized various swaps to hedge currency and interest rates exposure. As of September 2018, the REIT has hedged its JPY exposure until the first quarter of 2023, ensuring minimal interest and currency risks until the hedges are rolled over (industry jargon for renewing a hedge) then. The REIT has an average debt maturity of 3.1 years and a low average cost of debt, 0.94%, due to the low interest rates in Japan. At the point when the hedges have to be rolled over , depending on prevailing exchange and interest rates at that point, the REIT could incur considerably higher or lower interest expense then. Until then, interest expense is will remain very stable, though the REIT will not benefit if interest rates decline in the event of an economic slowdown or recession. The REIT's gearing level has remained below 40% over the last few years. 

REIT Management Fee Structure

1. Management Fee-
• Base Fee: 0.3% p.a. trust property value
• Performance Fee: 4.5% p.a. of trust's net property income 
2. Acquisition Fee - 1.0% of the value of real estate investment purchased or acquisition price 
3. Divestment Fee - 0.5% of the value of real estate or sale price 
4. Property Management Fees - 5.0% of capex for projects of capex less than S$1.0m, 3.0% of capex for projects of capex more than or equal to S$1.0m

PLife REIT's management fee structure does not fully align the interest of unitholders and that of the REIT management because the management incentive fee is based on NPI growth, rather than DPU growth. Under some circumstances, such as an absence of accretive opportunities, the management may be tempted to undertake DPU dilutive acquisitions just to boost DPU at the expense of unitholders. However, as PLife REIT has demonstrated a solid track record of managing this REIT and has not pursued any deals that have been detrimental to unitholders, I am not overly concerned by the fee structure. 

Conclusion

This is one boring REIT which will rarely spring a negative or positive surprise in its quarterly earnings. Its DPU ticks upward annually in an almost clockwork fashion due to the Singaporean assets' rental escalation of CPI + 1%. If you are looking for an investment with income (dividends) that is almost bond-like, but with some growth, look no further. I believe that PLife REIT deserves a place in any REIT or dividend portfolio to provide a stable and growing dividend stream.

For market data on this REIT and comparison against the market, please refer to my compilation of REITs here.

Disclaimer: I hold a position in this REIT at the point of writing. 

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