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REIT Investing Made Simple: A Checklist to Pick Out the Best REITs

New investors may find investing in real estate investment trusts (REITs) a daunting task since there are many things to look out for. I certainly did; when I first started investing in REITs, I was clueless.

To make life simpler for new REIT investors, I have created a checklist to follow, and you can find it below (the checklist has two parts — a quantitative aspect and a qualitative side — with 12 questions in all):

Quantitative Checklist

1. Gross revenue: Is it increasing consistently?
2. Net property income: Is it increasing consistently?
3. Distribution per unit: Is it increasing consistently?
4. Property yield: Is it between 5% and 9%?
5. Interest cover: Is it more than 4 times?
6. Gearing ratio: Is it below 35%?
7. Portfolio occupancy rate: Is it above the market average at least?
8. Price-to-book ratio: Is it below 1?
9. Distribution yield: Is it more than 6%?

Qualitative Checklist

1. Is the REIT’s sponsor responsible?
2. Does the REIT have right-of-first-refusal (ROFR) on properties?
3. Can the REIT grow with the property sector(s) it is in?

(If you need a refresher on what all the terms above mean, head here.)

When I invest in a listed company, I ideally want to see it making more revenue and net profit every year. Investing in REITs is no different. For REITs, I want to see consistent growth in gross revenue, net property income (NPI) and distribution per unit over the years.

A REIT’s property yield, in my opinion, is more critical than its distribution yield. I prefer property yields of between 5% and 9%. A yield that is too low could mean that the REIT is not maximising the income potential of its property, while a yield that’s too high may indicate that the REIT is charging exorbitant rent, which is unsustainable.

The interest coverage ratio is computed by taking a REIT’s NPI and dividing it by its finance costs. Any ratio above 4 is good for me. This shows that even if the NPI of a REIT were to drop, it can still pay interest on its loans without straining itself.

Gearing ratio is as important as the interest coverage ratio. In Singapore, REITs are required to have a gearing ratio of below 45%. As mentioned in an earlier article, I like REITs that have a gearing ratio of below 35% as this ensures there is enough room for error before the regulatory cap is breached.

Moving on, the portfolio occupancy rate shows the ratio of a REIT’s rented space to the total amount of space available. I like REITs that have full occupancy, or at least an occupancy rate close to 100%. No one likes to walk into an empty shopping mall. If a high occupancy rate is not possible, I prefer the REIT to have an occupancy rate that is at least above the market-average.

I analyse the valuation of a REIT by looking at its price-to-book (PB) ratio and distribution yield. I prefer REITs to have a PB ratio of below 1 and a distribution yield of above 6%. I believe a combination of these numbers give me good value.

Two main qualitative aspects I look at with a REIT are the traits of its sponsor, and whether the REIT can grow with the property sector(s) it is in.

In my opinion, First Real Estate Investment Trust (SGX: AW9U), an owner of healthcare assets in Asia, has one of the best sponsors amongst Singapore-listed REITs. Its sponsor, PT Lippo Karawaci Tbk, is Indonesia’s largest listed property outfit. As of 8 March 2018, the sponsor’s stake in First REIT was around 28%. This high insider ownership should align Lippo Karawaci’s interests with that of First REIT’s unitholders. Lippo Karawaci also has a strong pipeline of around 40 hospitals to which First REIT has the ROFR on. This means that the sponsor will offer the hospitals to the REIT first before any other party.

Other than growing through acquisitions, First REIT can also develop with the healthcare sector in Indonesia. In its 2017 annual report, the REIT said:

“With its [Indonesia’s] massive population, infrastructure development and a burgeoning middle class, the country’s healthcare market continues to be marked as a sustainable growth sector.

It has an underserved healthcare market, with low hospital bed and doctor ratios relative to the size of the population. According to a 2015 Frost & Sullivan Healthcare Outlook report, the Indonesia healthcare sector is expected to triple from US$7.0 billion in 2014 to US$21.0 billion in 2019.

With the growing demand for healthcare services in Indonesia and the ongoing national health insurance scheme, Jaminan Kesehatan Nasional (“JKN”), which targets to cover the entire Indonesia population of 260 million by 2019, First REIT’s portfolio of high-quality hospitals is well-positioned to serve the expanding healthcare market.”

The Foolish bottom line

The checklist presented above is by no means exhaustive. It also does not mean that if you follow the criteria listed strictly, you would not see any losses in your REIT portfolio. But, the checklist should at least point investors to the right direction when investing in REITs.

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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 First Real Estate Investment Trust. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.