WHAT MAKES A GOOD REIT?

Since the debut of the country’s first real estate investment trust (REIT) AREIT in the Philippine Stock Exchange (PSE) last year, REITs have been fast gaining popularity among Filipinos. This is not surprising considering that REITs are a good alternative to physical properties for investors who want to earn rental income, with the benefit of being more affordable, diversified, easier to manage and sell.

However, not all REITs are created equal. Here is a check list of factors to consider when investing in REITs.

Quality of assets in the portfolio. Like any physical property, the growth outlook of the different properties owned by the REIT is very important in determining whether the company can pay stable cash dividends that increase over time.

Invest in a REIT that owns properties belonging to growing sectors. That way, it will be easier for the company to enjoy consistently high occupancy rates and charge its tenants higher rents. For example, despite the pandemic, demand for offices and warehouses remains resilient while demand for retail spaces and hotels is weak. It is not surprising then that all of the REITs that are listed and that plan to list own office buildings.

The quality of assets that are part of a REIT’s portfolio and the background of its tenants are also important.

For example, while demand for offices is relatively resilient, grade A offices that have Philippine Economic Zone Authority (Peza) accreditations found in prime locations enjoy much stronger demand. Meanwhile, offices that have a significant exposure to Philippine offshore gaming operators (Pogo) tenants have a greater risk of suffering from higher vacancy rates compared to offices that cater to business process outsourcing (BPO) tenants.

Balance sheet strength. When buying REITs, look for a company that has a strong balance sheet with minimal debts. This will determine how much the company can expand through acquisitions by leveraging up. Under the law, the total borrowings and deferred payments of a REIT are limited to 35 percent of its deposited property. If a REIT company’s debt level is already close to the said level, its profit growth will largely be limited to increases in rental rates and occupancy rates.

Background of the sponsor. Given the difficulty in acquiring good rental properties from non-affiliated companies, the background of a REIT’s sponsor (or the major owner of the REIT company) is important, being a rich source of potential assets that can be acquired by the REIT company. Note that a REIT company that is sponsored by a real estate company with a large portfolio of attractive rental properties has a natural advantage in growing its asset base, profits and cash dividends to shareholders.

When buying REITs, look for a company that has a strong balance sheet with minimal debts. This will determine how much the company can expand through acquisitions by leveraging up

Valuation. Invest in REITs that are trading at a reasonable valuation. Note that the most important valuation measure in valuing a REIT is its dividend yield. At present, the average estimated 2022 dividend yield of the two listed REITs, AREIT and DDMP REIT, is 5.8 percent.

Ideally, new REITs that plan to list should have a dividend yield that is higher than 5.8 percent. If it is lower, there should be a good reason for the disparity such as the REIT’s relatively more attractive asset portfolio, or its better growth outlook in terms of rental rates, occupancy rates or assets injections.

If the difference cannot be justified, it might be better to wait for the REIT to list in the PSE and for its share price to drop to more attractive levels before buying. After all, a good REIT, like any good company, can become a bad stock if it is priced expensively.

With this framework, I hope that everyone who reads this article will be in a better position to identify good REITs. Happy investing!