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How You Can Pick Winning REITs

Nearly a year ago on 7 March 2018, The Motley Fool Singapore launched its first – and currently only – investment newsletter that is focused on real estate investment trusts, Ultimate 8. It has produced superior investment returns since inception, and I thought it will be useful for all Singaporean investors if I shared an overview of what has driven the success of Ultimate 8 thus far.

Setting the stage

In Ultimate 8, my colleagues and I in Fool Singapore’s investing team recommended eight Singapore-listed REITs. From the service’s launch on 7 March 2018 to 26 February 2019, the eight REITs we selected have delivered an average return of 10.0%, including distributions.

Over the same timeframe, Singapore’s stock market benchmark, the Straits Times Index (SGX: ^STI), has lost 2.0% after accounting for dividends. What’s also interesting is that of the Singapore-listed REITs I have pricing data on for the same time period – a 40-strong list – their average return was just 4.4% (again including distributions). If I exclude the eight REITs recommended in Ultimate 8, the remaining 32 REITs have produced an average gain of merely 3.0%.

It’s thus clear that the REITs my colleagues and I have recommended for our investment newsletter have significantly outperformed both the Singapore stock market as well as REITs in general.

What has driven our success

There are a few common threads that tie Ultimate 8’s REITs together:

1. Most of them have long track records of growth in gross revenue (essentially rent the REITs collect from their properties), net property income (what’s left from the REITs’ rent after paying expenses related to the upkeep of their properties), and in particular, distribution per unit. Based on my experience interacting with investors, the last point is often overlooked, despite it being a crucial part of evaluating REITs, in my opinion.

A REIT may fuel its growth by issuing new units as currency for property acquisitions, hence diluting existing unitholders’ stakes. The end result is a REIT with growth in gross revenue, net property income, and distributable income, but a stagnant or declining distribution per unit.

2. Many of the REITs have either favourable lease structures that feature annual rental growth, or have demonstrated a long history of being able to increase their rent on a per area basis. This trait helps improve the chances that our REITs can enjoy organic growth.

3. Our REITs tend to have low gearing ratios (defined as debt divided by assets) and a healthy ability to service their borrowings. At the time of Ultimate 8’s launch, our REITs had an average gearing ratio of 33.7%, which is a fair distance from the regulator-mandated gearing ceiling of 45%. The low gearing ratio confers our REITs two advantages: First, it increases the financial fortitude our REITs have to last through tough times; second, it provides our REITs the room to take on debt to make property acquisitions for growth. Regarding the ability of Ultimate 8’s REITs to service their borrowings, they had an average interest coverage ratio of 6.2 at the time of our recommendation.

In contrast, Soilbuild Business Space REIT (SGX: SV3U) – a REIT we avoided in Ultimate 8 that has not done well (a loss of 0.3% since the service’s inception) – had a gearing ratio of 40.6% and an interest coverage ratio of 4.7 at the time of our newsletter’s launch.

4. Some of our REITs also had clear growth prospects, such as newly-acquired properties with attractive characteristics, or properties that are undergoing redevelopment that have the potential to deliver higher rental income in the future.

A good process is key

Have all of the REITs in Ultimate 8 been winners? Nope. In fact, the second-worst performer among the 40 REITs I have pricing data on from 7 March 2018 to 26 February 2019 is a recommendation in our service: First Real Estate Investment Trust (SGX: AW9U), which has delivered a loss of 16.9%.

The presence of First REIT in Ultimate 8 is a great reminder that there is no method for selecting investments that will result in winners all the time. What’s important is to build a diversified portfolio of shares that are picked with a sensible investment process. Doing so stacks the odds of overall success in our favour. We may end up with some losers, but the winners will more than compensate. To this point, three of the top-five performing REITs are recommendations in Ultimate 8 – and let’s not forget that the eight recommended REITs in the service (including First REIT!) have an average return of 10.0% since the service’s inception, which is far better than the average-REIT’s return of 4.4%.

The Foolish bottom line

When you’re out looking for REITs to invest in, keep an eye on a few factors:

1. Growth in gross revenue, net property income, and crucially, distribution per unit.
2. Low leverage and a strong ability to service interest payments on debt.
3. Favourable lease structures and/or a long track record of growing rent on a per-area basis.
4. Catalysts for future growth.

Happy hunting for 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 writer Chong Ser Jing does not own shares in any companies mentioned. The Motley Fool Singapore has a recommendation on First Real Estate Investment Trust.