Things to keep in mind when investing in new REITs

After AREIT and DDMP REIT, two more real estate investment trusts (REITs) will soon debut in the Philippine Stock Exchange (PSE)—Filinvest REIT and RL Commercial REIT.

Here are some things to keep in mind when deciding whether to subscribe to the two new REIT companies’ initial public offering (IPO).

Quality of assets in the portfolio. The growth outlook of the properties owned by a REIT company is very important in determining whether its stock will perform well once it lists in the market.

Determine whether the properties owned by a REIT company belong to a growing or a cyclically weak sector. This will largely determine whether the REIT company can grow its profits and dividends to shareholders by charging higher rents and increasing its average occupancy rate. For example, despite the pandemic, demand for offices and warehouses remains resilient while demand for retail spaces and hotels is weak.

The quality of assets that are part of a REIT company’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 accreditation 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. The strength of a REIT company’s balance sheet is important because it 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 is limited to 35 percent of its deposited property. If a REIT company’s debt level is close to the said level, then its profit growth will be largely limited to increases in rental rates and occupancy rates.

Background of the sponsor. The background of a REIT company’s sponsor is important because the sponsor is a rich source of potential acquisitions for the REIT company. For example, since listing in 2020, AREIT has already acquired several assets from its sponsor, Ayala Land, including the 30th commercial development in Pasig, which includes an office building that is being leased predominantly by BPO tenants, and a 9.8-hectare land in Laguna Technopark that is being leased by Integrated Micro-Electronics, Inc. As demonstrated by AREIT, a REIT company that is sponsored by a real estate company with a large portfolio of attractive rental properties has an advantage in growing its asset base, profits, and cash dividends to shareholders.

Valuation. For a REIT to be successful, the company must price its shares at a reasonable valuation.

The first step in valuing a REIT is to derive an estimate of its full-year cash dividend. By law, a REIT company must pay out at least 90 percent of its income as cash dividends to shareholders to avail of tax benefits. The next step is to compute its dividend yield (which is its dividend per share divided by its price), then compare this with the average dividend yield of other listed REITs. Note that the average estimated 2021 dividend yield of AREIT and DDMP REIT is currently 5.3 percent. Ideally, the new REIT companies that will list should have a dividend yield that is higher than 5.3 percent. If it is lower, there should be a good reason for the disparity such as the REIT company’s relatively more attractive asset portfolio, or its better growth outlook in terms of rental rates, occupancy rates and/or assets injections. If the difference cannot be justified, it might be better to wait for the REIT to list in the PSE and to wait 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 decide whether to subscribe to the two new REIT companies that will soon have their IPOs. Happy investing! INQ