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Are Small REITs Better Than Large REITs?

Real Estate Investment Trusts or REITs are a popular investment here in Singapore. Perhaps it is our love property that makes them appealing. Or maybe it is because of our yearning for regular income.

It could be more of the latter. In many ways, REITs can be thought of as a proxy for bonds. They even behave a little like them, sometimes. Of course, it can be argued that many blue-chip stocks have bond-like characteristics too.

Interesting times

When there is a possibility that interest rates might rise, the price of blue chips – just like bond prices – could fall. But when the market believes that interest rates could fall, then the share price of these companies could rise.

But REITs could be even more sensitive to interest-rate movements. That is because investors who buy REITs are constantly reviewing their prospective yields rather than looking at the prospect of capital appreciation. For some, it is about jam today rather than jam tomorrow that count.

So, when the market believes that an interest-rate increase is on the cards, then shares in REITs could fall – sometimes quite disproportionately.

Attractive REITS

That is why it is important to consider buying REITs when they are attractively valued. It could provide a good margin of safety.

But what is an attractive valuation? A common approach is to look at yields. It is quick, it is simple, and it is widely reported. But that could also be a mistake.

REITs are required pay at least 90% of their distributable income as dividends. So, managers have no discretion over how much to reward unit holders.

Currently, the median yield on Singapore REITs is about 7.2%. That is roughly twice the dividend yield for the entire market.

Size matters

The yields on smaller REITs tend to be higher than those of the larger ones. Larger REITs are generally those with a market value of more than $2 billion.

The median yield for these larger REITs is about 5.9%. CapitaLand Commercial Trust (SGX: C61U) and SPH REIT (SGX: SK6U) are yielding around 5.7%, which is about a-fifth lower than the market average for REITs.

The yields on smaller REITs, on the other hand, are about a-fifth higher than the average. For example, Cache Logistics (SGX: K2LU) and AIMS AMP Capital Industrial REIT (SGX: O5RU) offer historic yields of 9.0% and 8.7%, respectively.

So from a perspective of yields, smaller REITs appear to be cheaper than larger ones.

Book lovers

There is another way to value REITs, which is to look at how much it costs to buy a dollar of their assets. Currently, we are, on average, paying about 86 cents to buy a dollar of their assets. In other words REITs are trading at a 14% discount to their net assets.

The discount is across the board. So there is little to choose between the larger and the smaller REITs.

Earning power

Another way is to look at how much we are paying for a dollar of earnings. But the usual way of comparing price to profits is not very helpful when valuing REITs. That is because general accounting principles may not always be an accurate representation of a REIT’s true performance. Cash from their operations can be a better measure.

In Singapore, we pay around $13 for every dollar of cash generated by REITs. Curiously there is little to choose between larger REITs and their smaller counterparts.

Tales of the unexpected

This is a little unexpected because, intuitively, larger REITs should be more attractive to deep-pocketed institutions. Big investors tend to lean towards the bigger stocks for their liquidity. After all, it can be difficult to buy needle-moving quantities of smaller REITs without owning the whole thing outright.

The upshot is that here in Singapore there is little to choose between large and small REITs. We pay roughly the same for their stream of earnings, regardless of the size of the company.

At the current yield of around 7.2%, we could, in theory, double the value of our investment in around 10 years, if REITs could maintain their distributions. That doesn’t seem too outrageous at all, provided you have the patience.

A version of this article first appeared in The Straits Times.

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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 Director David Kuo doesn’t own shares in any companies mentioned.