Battle of the REITs – A-REIT vs MIT | Company Analysis

2017 looks to be another year shrouded in uncertainty, amidst a litany of geopolitical and economic overhangs – the surprise Brexit vote and the election of Donald Trump as US President, negative interest rate policy at major central banks, fears of a slowdown in China, a slump in commodities and low oil prices, an ongoing fall in corporate earnings, fears of a recession… the list goes on and on. 

For the garden variety investor, picking stocks for one’s portfolio has become something of a conundrum, as 2017 looks to be another volatile year for the stock market.

Real Estate Investment Trusts (REITs) once again look set to be the bedrock of any stock portfolio, with their decent dividend yields and relative price stability helping to cushion against the impact of volatility. However, the outlook for Singapore-listed REITs is less than sanguine, with interest rates set to rise coupled with the backdrop of a slowing economy. Nonetheless, REITs still can offer a superior dividend yield over common blue chip stocks, at the expense of lower capital appreciation. 

Choosing the right REIT however, can be a tedious process. For one thing, the REIT must be able to sustain its current dividend payouts in an uncertain future, while concurrently growing revenues and expanding the business by acquiring more properties. Certain industries, such as office space REITs, face an oversupply problem which puts pressure on rental yields. Retail REITs are seeing lower shopper traffic at malls, while hospitality REITs have to cope with declining visitor numbers. 

Also, with the looming threat of rising interest rates, REITs with a high gearing ratio, or those which have not sufficiently hedged their borrowings to fixed rates could face potential problems. 

In view of the uncertain conditions facing REITs in industries such as office space, I would pick industrial REITs for exposure to this asset class. Don’t get me wrong though, industrial REITs do face their fair share of challenges with a slowing local economy. However, this particular industry is probably the best place to ride out the storm, putting one’s faith in the resilience of Singapore’s industries.

I have chosen the 2 of the largest industrial REITs to review: 

-        - Ascendas REIT (A-REIT) -- probably the oldest REIT in Singapore, having listed in 2002

-        - Mapletree Industrial Trust (MIT) – one of the many Mapletree REITs (a branch of the maple tree, get it?)

Big Brother Ascendas REIT (Ticker: A17U.SI)

The first and the largest business space and industrial REIT, Ascendas owns 131 properties worth over $9 Billion, spanning Singapore, Australia and China. It offers some sort of geographical diversification away from Singapore which could translate into more stable revenues. 

A component of the Straits Times Index, the REIT’s performance over the years has been nothing short of remarkable, in part thanks to excellent management. It has managed to grow its revenues and dividends year after year. But this excellent track record leaves high expectations for future performance.

Fiscal Year	11/12	12/13	13/14	14/15	15/16
Revenue	503,304	575,837	613,592	673,487	760,988
NPI1	368,337	408,810	435,973	462,727	533,701
Net Income	274,528	307,346	391,033	267,953	372,815
Adjusted Funds From Operations	238,094	248,328	276,963	119,140	238,827
Dividends paid	270,092	309,376	325,815	260,786	442,085
DPU*	13.56	13.74	14.24	14.60	15.36
NAV/share	$1.88	$1.94	$2.02	$2.08	$2.06

*All figures in thousands of SGD except DPU, which is in Singapore cents

¹NPI: Net Portfolio Income

What we see here is in excellent set of figures that would leave other companies green with envy. Consistent revenue and NPI growth, increasing dividends as well as net asset value are all hallmarks of competent management. Dividend payouts, however, are persistently above adjusted funds from operations (AFFO), which could well mean that a portion of the dividends are financed by borrowings. 

While most REITs pay distributions based on what is termed as “total amount available for distribution”, that component is affected by changes in fair value of derivative contracts held, as well as valuation fluctuations of its properties. It does not reflect the “core” earnings of the REIT, or the actual cold hard cash made or lost. 

Adjusted funds from operations (AFFO) seeks to capture just that, it can be viewed as the REIT equivalent of free cash flow, given by the formula AFFO = Net Income + Depreciation and Amortisation – Net Gain on Sales of Property – Capital Expenditures

All figures in thousands of SGD.

While the dividend payouts are seemingly partially funded by debt, this is dictated by the capital structure of a REIT. Since a REIT is legally obliged to payout at least 90% of its net income, cash generated by core operations would be stretched to pay dividends in lieu of capital expenditures and investment needs (to buy more properties), thus some of the cash used to pay dividends has to be borrowed. 

Nonetheless, on should not be overly concerned so long as revenue and net income continue to grow, while the properties owned by the REIT continue to appreciate in value. 

Sustainability

 

Fiscal Year	11/12	12/13	13/14	14/15	15/16
Aggregate Leverage	36.6%	28.3%	30.0%	33.5%	37.3%
Percentage Fixed Debt	55.8%	74.8%	65.3%	68.2%	71.9%
WACD*	2.8%	3.3%	2.7%	2.7%	2.8%
Interest Cover Ratio	5.3x	4.9x	6.0x	5.5x	6.1x
Total Debt/Net Income	8.7x	5.4x	5.6x	6.5x	7.9x
WALE**	4.0 yrs	3.7 yrs	3.9 yrs	3.8 yrs	3.7 yrs
Portfolio Occupancy	96.4%	94.0%	94.0%	87.7%	87.6%

*WACD: Weighted Average Cost of Debt

**WALE: Weighted Average Lease Expiry

Moving on, we see that A-REIT has maintained a sustainable financial position, with aggregate leverage never above the 40% mark (which would raise some eyebrows), or the 45% level (which could get it into legal trouble). A large proportion of its borrowing have been hedged to fixed rates, or are borrowed at fixed interest rates, thereby cushioning the impact of a rise in interest rates on net income. 

However, the gearing ratio on the higher side on 30% is slightly concerning for a REIT of this size, especially when it has been rising for 4 years consecutively. It appears that management is on a, property acquisition spree, funding those acquisitions with loans. So far this strategy appears to be working, with revenues growing more than 30% over these 4 years.

 

Carrying an investment grade rating, A-REIT is able to enjoy cheaper financing as seen by its manageable cost of borrowing (WACD). Interest cover ratio is sufficient at 6.1x, but total debt relative to net income has been increasing, and total portfolio occupancy falling, a slightly worrying sign. However, the drop in portfolio occupancy can primarily be attributed to the weakening Singapore economy as well as the slight oversupply in industrial space. 

The rental expiries have also been well staggered into the future, and thus weighted average lease expiry (WALE) has been somewhat constant at around 3.8 years, with most tenants locked in on their rents for around this period of time. This should provide a constant stream of income over the next few years, assuming that tenants do not default en masse. 

Head of the Family: Mapletree Industrial Trust (Ticker: ME8U.SI)

This industrial offering from the Mapletree family of REITs comprises 85 industrial properties such as flatted factories, business parks and light industrial buildings, focused entirely on Singapore, thus offering no geographical diversification. 

Fiscal Year	11/12	12/13	13/14	14/15	15/16
Revenue	246,371	276,433	299,276	313,873	331,592
NPI	171,320	195,436	214,739	228,613	245,116
Net Income	126,337	145,560	163,992	177,992	190,616
Total Return for the Year	220,429	279,271	314,253	374,340	272,580
Adjusted Funds from Operations	125,723	128,369	116,347	157,720	183,060
Dividends paid	123,852	132,918	97,331	97,459	114,554
NAV/share	$1.02	$1.10	$1.20	$1.32	$1.37

All figures in thousands of SGD.

My comments about MIT (Mapletree Industrial Trust) are similar to those of Ascendas REIT. Solid revenue growth and increasing net incomes, coupled with increasing net asset values. Once again, both metrics show that management is on the right track. 

Dividends paid may look unstable through the years, and may appear to be overly conservative, being perpetually less than AFFO. However, MIT runs a dividend reinvestment policy that gives unitholders the option to forgo their dividend payouts each quarter in exchange for new units in the REIT. This continually expands the unit base and increases equity in the REIT, therefore helping to keep overall leverage lower while somewhat reducing the need to take on debt. 

While it is a shrewd move to lower leverage, this measure could exhaust shareholders, who are inclined to subscribe to new units continually or face potential dilution. They also forgo their dividend income. Such a measure only works in a bull market where units keep rising in price, to compensate for the dilution effect. 

Sustainability

 

Fiscal Year	11/12	12/13	13/14	14/15	15/16
Aggregate Leverage	37.8%	34.8%	34.4%	30.6%	28.2%
Percentage Fixed Debt	85.0%	88.0%	73.1%	86.8%	88.0%
WADC	2.2%	2.4%	2.2%	2.1%	2.4%
Interest Cover Ratio	6.4x	6.4x	7.1x	7.5x	7.4x
Total Debt/Net Income	8.4x	7.1x	6.9x	6.0x	5.4x
WALE	2.5 yrs	2.4 yrs	2.5 yrs	3.1 yrs	2.8 yrs
Portfolio Occupancy	94.7%	95.2%	92.8%	90.9%	94.6%

As mentioned, the option to subscribe to new units has kept gearing lower than its counterpart A-REIT. Most debt is hedged or taken at fixed rates, with interest rates at an affordable 2.4%, due to an investment grade rating of BBB+ from Fitch. 

What sets it apart from A-REIT is the higher interest cover ratio and lower total debt relative to net income. It appears that management have pursued a different strategy from A-REIT, being less aggressive in debt-funded acquisitions. 

But compared to A-REIT, the future of its rental incomes look a little more uncertain, with WALE at only 2.8 years, nearly a year off A-REIT’s WALE of 3.7 years. That means that a greater proportion of rents are due to be renewed in the nearer future and once again that puts uncertainty on the rental revisions. Given the potential oversupply in industrial space and a slowing economy, MIT may not achieve the rental rates as it desires (higher, of course). However, the higher and more consistent portfolio occupancy rate is somewhat a redeeming factor.

A Comparison of Valuations

	A-REIT	MIT
Price/Earnings Ratio	18.9	10.8
Price/Book Ratio	1.11	1.20
Dividend Yield	6.4%	6.82%
500 Day Beta	0.718	0.347
500 Days R-Squared	20.10%	9.58%

*Data obtained from ShareInvestor on 13/11/16

We see how closely-matched both REITs are. A-REIT commands a higher P/E ratio possibly due to its perceived stability of payouts. The discrepancy in dividend yields can be attributed to the different credit ratings assigned to both REITs. A-REIT commands a credit rating of A3 from Moody’s, while MIT is one notch lower at BBB+ from Fitch. Both ratings are for notes due in 2026. Thus, A-REIT is perceived to be “safer”, justifying its slightly lower yield. 

However, price stability wise a different picture is painted. With a 500-day rolling beta of 0.718 and an R-Squared of 20.1%, the volatility of A-REIT can be expected to be much higher than that of MIT, with a beta of just 0.347 and R-Squared of just 9.58%. One reason could be that A-REIT is a component of the Straits Times Index (STI) and hence could exhibit a greater correlation to fluctuations in the benchmark. Any long term investor in A-REIT must be prepared to weather greater fluctuations in prices than in MIT.

Upsides and Downsides

	The Pros	The Cons
A-REIT	-          One of the largest and oldest REITs, the brand name Ascendas appears to be a buy-word for “stable” and “safe” -          Long term stability of dividend payouts -          Ease of raising new capital – rights issues and private placements are bound to find buyers -          Geographical diversification – properties in Australia and China	-          Rising leverage could be a concern if returns begin to deteriorate -          Keep an eye on the portfolio occupancy rate – acquiring new properties is only beneficial provided there are tenants!
MIT	-          Relatively large portfolio size + stability of dividend payouts -          Ample “headroom” with lower gearing ratio – ability to take on more debt to finance new acquisitions -          Scheme for subscription to new units is a shrewd move under the right market conditions	-          New units issued every quarter dilute existing shareholders who opt out of the scheme + Unitholders do not see dividend income and run the risk of prices falling, under the subscription scheme -          Less aggressive rate of acquisitions than A-REIT could mean lost opportunities for growth? -          No geographical diversification – all properties in Singapore

The Final Word

Both REITs are rather similar and it is hard to make a case for one over the other. While A-REIT is certainly more established, has a larger property portfolio that includes overseas properties and is somewhat safer with a higher investment grade rating, MIT looks more attractive valuations wise, together with its lower gearing and lower volatility as well as slightly higher yield. 

Rather than try to pick one out of the two, investors with sufficient funds and are seeking exposure to industrial REITs in 2017 could simply add both REITs to their portfolios. Their relative merits and demerits would offset each other and in the long run the investor is still well off making a dividend yield of more than 6%, assuming payouts do not fall.

The only problem now is with entry price. At current prices, both REITs are looking a bit steep. A better time to buy them would be after a market-wide rout, or an interest rate hike which sends higher yielding equities plummeting. Only then could these attractive gems be picked up at attractive prices.

Just my two cents.