A REIT with a portfolio of properties that can appreciate in value over the long term can reward unitholders in two ways.
Firstly, it can unlock unitholder value when it sells the asset at a profit. Secondly, a portfolio that appreciates in value increases the book value of the REIT, thereby giving it a larger asset base to increase its debt load to fund further acquisitions; this could, in turn, increase the REIT’s distributions to unitholders.
So, how can investors identify REITs that have portfolios that could potentially grow in value? Here are two things to look at.
Free-hold or long land-lease tenures
The length of the land-lease tenures of a REIT’s property portfolio is crucial in predicting its likelihood to appreciate in value. Properties that sit on land that are free-hold are more likely to increase in value over time, whereas properties that are on land with short lease tenures are likely to start depreciating in value as the land-lease maturity date approaches.
A case in point is Parkway Life REIT (SGX:C2PU), which has properties that are either on free-hold land, or land with long leases. Partly because of this strategy, the REIT has managed to report valuation gains in its portfolio on a very consistent basis. For instance, its properties had a valuation gain of S$26 million in 2017, S$18.2 million in 2016, S5.7 million in 2015, and S$45 million in 2014.
This consistent growth in the value of Parkway Life REIT’s portfolio provides a larger asset base on which it can borrow more to further expand its portfolio.
On the point about borrowing, REITs have a regulatory gearing limit of 45%, where the gearing ratio is calculated by dividing total debt by total assets. From this, you can see that having a high asset base enables more debt to be taken on by a REIT.
Assets located in high-growth markets
REITs that have assets that are strategically located in high-growth areas are also more likely to experience asset revaluations.
Take CapitaLand Retail China Trust (SGX: AU8U) for example. The REIT owns a portfolio of 11 retail malls in China. I will take one of its properties – CapitaMall WangJing – as a point of reference. CapitaMall WangJing is a shopping mall located in the densely populated residential suburb of Wangjing in Beijing.
Because the property is located in such an optimal market, it has seen positive revaluations consistently over the past few years; its value has grown from RMB 1.43 billion in June 2011 to RMB 2.38 billion currently. The growth has happened despite the fact that the property sits on a piece of land with a relatively short lease (expiry is in 2043).
The Foolish bottom line
Positive revaluations of a REIT’s properties may not directly lead to cash inflows for the REIT. However, it is still essential that investors do not underestimate the importance of such revaluation gains. Not only can the REIT realise its gains in the future, but it is also important in improving the REITs ability to take on more borrowings, which can fuel future growth.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended units of CapitaLand Retail China Trust and Parkway Life REIT. Motley Fool Singapore contributor Jeremy Chia doesn’t own units in any companies mentioned.