How to Pick a REIT for Sustainable Dividends

My fellow Fool Ser Jing once wrote that The next best thing from being a property owner yourself, is to own real estate investment trusts, or REITs”. It turns out that my Foolish colleague is in good company with that sentiment. Author Bobby Jayaraman, in his book Building Wealth Through REITs, sharedthat there are a few advantages to owning REIT shares. Mr. Jayaraman is also the Chairman of the Remuneration Committee for Second Chance Properties Ltd (SGX:528).

Being a shareholder of a REIT gives you partial ownership to the real estate that it owns. Having partial ownership also entitles you to the dividend distribution which typically happens every quarter. As per the Monetary Authority of Singapore (MAS), REITs are mandated to distribute at least 90% of its profits as dividends in order to enjoy tax transparency.

The advantages of REITs include access to diversified properties, better liquidity, and the relatively low capital outlay to own pieces of property. However, does this mean that we just go ahead and buy any REIT that comes along?

Businesses, not tickers

As Foolish investors, we look at shares as businesses and not tickers. It follows that we should always do our homework to ensure that the dividend yield offered by a REIT is sustainable, and is able to grow over the long term. To this, author Bobby Jayaraman had a few suggestions to share in his book. Below are three things that Foolish investors might want to look out for in a REIT.

Net property income or NPI

Mr. Jayaraman shared that the NPI is very important number as it signifies the earnings power of a property. The NPI is defined as the gross rental revenue of a property minus all related expenses. In this instance, the attractiveness of a REIT might depend on the strength and sustainability of the NPI.

To quote an example, the NPI for Frasers Centerpoint Trust (SGX:J69U) for the financial year ended 30 September 2009 (FY 2009) was $59.9 million. Fast forward five financial years, and the REIT managed to grow its NPI to $111.6 million for FY 2013. This sizable uptick in NPI may have resulted in the share price for Frasers Centerpoint Trust increasing by around 142% from 1 Oct 2008 to 1 Oct 2014.

The underlying business and its sector

In his book, REITs were broadly categorized into Retail, Hospitality, Health Care, Industrial, and Cross-border. As it is with different business sectors, each REIT sector above is unique, and can be influenced by different factors. As such, understanding the different considerations of the category is a key part of understanding the REIT itself.

For instance, Industrial REITs like Cache Logistics Trust (SGX: K2LU), or Mapletree Industrial Trust (SGX:ME8U) may be more sensitive to economic fluctuations in the manufacturing sector, or the logistics sector. On the other hand, Health Care REITs such as Parkway Life REIT (SGX:C2PU) may be show more resilience during recessions as health care is often seen as a non-discretionary expense.

Track record in funding

For Mr. Jayaraman, the sources and types of financing that the REIT has is a critical area to look into. A variety of funding possibilities gives a REIT flexibility to thrive in different market environments. Besides that, the leverage and debt profile of the company also provides clues on the sustainability of a REIT in different interest rate environments.

For instance, CapitalMall Trust (SGX:C38U) presented on 26 August 2014 (for Macquerie ASEAN Conference 2014) that 98.7% of its borrowings are based on fixed interest rates. This makes the REIT less vulnerable if there were interest rates changes in the near future. On top of that, 82.9% of its debt was also unsecured, therefore there is a possibility that the REIT is able to pledge its properties in times of weak credit markets to gain further financing. On the other side of the coin, individual investors would still have to observe the level of interest rates that the REIT is able to secure when it refinances its debt.

Foolish take away

Perhaps the most attractive feature of a REIT share is the relatively high dividend yield it offers to individual investors.

Foolish investors, though, would do well in performing their own homework in determining whether or not the dividend yield offered is sustainable. As it is with any other businesses, the track record of the management team in creating value for the REIT, and managing funding for growth will matter as well.

The pointers above serve as general guidelines to evaluate a REIT. To move forward, Foolish investors might want to study the their chosen REIT over time to gain a comparable advantage. Foolish Investors can also learn more by signing up for a FREE subscription to The Motley Fool’s weekly investing newsletter, Take Stock SingaporeSign up here to learn how you can grow your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Parkway Life REIT.