Most investors buy into Singapore’s biggest Real Estate Investment Trusts (REITs) for a stable recurring income through dividends.
Apart from looking for REITs that deliver stable dividends, better known as distribution per unit (DPU), investors also look for REITs that gradually increase their DPU over time.
Unlike most companies that would retain earnings to reinvest in the business for growth, REITs pay out at least 90% of their profits as dividends.
This means that a REIT will most likely have to raise funds for growth. This will come either from its unitholders or borrowings from banks and capital markets.
The growth strategy that a REIT embarks upon will depend on the type of properties owned as well as the lease structure.
Broadly speaking, Singapore REITs can generate growth within their existing properties in two ways. The first is via organic growth and the second is by acquiring new properties (or inorganic growth).
Let’s take a look at the two growth routes for REITs in further detail.
Organic growth
1. Increase in rentals
This is the most obvious way to generate growth and retail REITs have been very successful at this over the past decade.
Other REITs, such as office REITs or specialised REITs, depend on the state of the economy and whether the supply-demand dynamics are favourable to the landlord or tenant.
REITs with long-term master leases – such as healthcare and hospitality REITs – usually have built-in rental increases for their base income. In addition, there’s also some form of profit-sharing for the variable income.
2. Asset enhancement initiatives (AEIs)
Asset enhancement initiatives (AEIs) means that the REIT will maximise their yield per square foot by converting lower-yield space into higher-yielding ones.
Retail REITs will usually upgrade their tenant mix by converting low-yield supermarket space into higher-yield luxury goods space.
Sometimes, the repositioning of the mall will also allow an increase in its overall yield.
As for the non-retail REITs, asset enhancement is limited to value enhancement.
For example, refurbishments will be done in office and hospitality sectors to maintain competitiveness with newer properties.
Inorganic Growth
1. Acquisitions
In terms of inorganic growth, a REIT manager will look for opportunities to acquire a good property in the market.
This will be based on the potential benefits in terms of increased rentals, which will more than offset the cost of debt.
This will lead to higher DPUs for the unitholder and these are often labelled as a “yield-accretive” acquisition.
However, yield-accretive acquisitions are usually not easily available. In an uptrend market (when funding is easily obtained) properties are usually valued at a premium.
Meanwhile, properties that are available at attractive valuations in a downtrend will be faced with higher costs of borrowing. That’s because bank loans are usually harder to procure during a weak market.
2. Development of properties
Another way for a REIT manager to drive growth is through the development of a property (or properties), similar to a property developer. This is usually known as the greenfield development.
In Singapore, REITs are only allowed to spend a maximum of 10% of their asset value in greenfield development. Therefore, this tends to restrict this type of development to the larger REIT players only.
This will add long-term value to unitholders, as the margin from greenfield development is higher when compared to acquisitions from the secondary market.
The downside to this growth strategy is the long period of time required for the property development to be completed and start generating income.
Understanding what drives REITs’ growth
It is clear that REITs are not an investment asset class catered to those seeking high-growth returns but it is important for investors to have a clear understanding on what drives growth for REITs.
For example, is the REIT’s increase in DPU led by its organic growth or is it acquisition-driven?
Organic growth carries much lower risk while acquisition-driven growth will lead to an increase in its debt levels.
Generally, a REIT that manages to increase its rental income, undertake AEIs and is disciplined in is acquisition strategy, will create more sustainable long-term value for investors.
Disclaimer: ProsperUs Investment Coach Billy Toh doesn’t own shares of any companies mentioned.
