S-REIT: Are We Blinded By Yield?

by Raymond Leung and Simon Ang 28/05/13 12:30 pm

In this low interest environment, investors have been actively seeking yield through investments in dividend paying stocks and REITs. However, the recent sell-off of Keppel REIT by Keppel Corp have sparked the question: Are we overpaying for S-REITs?

Sale Of K-Reit Stake
 In the past week, the sale of Keppel Reit (K-Reit) by Keppel Corporation to Goldman Sachs has sparked the discussion of the overvaluation of S-REITs. This, the result of buying behaviour exhibited by investors chasing yield. This is the second divestment of K-Reit by Keppel Corp this year following the sale of stake through a placement to unknown buyers arranged by Barclays Bank.

Goldman Sach purchased 180 million units at $1.555 apiece which is a 6.7 percent stake in Keppel-REIT from Keppel Corp. The placement price of $1.555 was a 3.1 percent discount to the market price of $1.605 on the day the announcement was made. Based on the placement price of $1.555 and the dividend of $0.0777 per share paid to investors for FY2012, the implied yield for Goldman Sachs on K-Reit will be 5 percent compared to 4.84 percent retail investors based on the price of $1.605.

Liquidity And Chasing Yield
 In the current low-interest environment with Singapore Government 10-year bonds yielding only 1.6 percent, investors in Singapore have been actively seeking yield from the market thus boosting liquidity. With such ample liquidity, Singapore has been attracting initial public offerings (IPOs) of various REITs and Business Trusts (BT) for IPOs.

This year alone, we saw the IPO of Mapletree Greater China Commercial Trust (REIT), Croesus Retail Trust (BT) and Asian Pay Television Trust (BT). Despite the large issues from these IPOs, more REIT IPOs are on the way.

Speculation is rife that companies such as SPH, OUE, Hoo Bee and Banyan Tree are looking to spin off assets to form the basis of REITs which will then list on the Singapore Exchange. A recent update from SPH mentioned that it expects to raise about $540 million from an asset spin-off (Paragon and the Clementi Mall) into a REIT. The IPO of this REIT is expected to be in early July.

Despite having new IPOs of REITs and BTs, there is still ample liquidity in the market which has led to the compression of yields of REITs. The compression was mainly attributed to the higher prices of REITs which have lead S-REITs to trade at an average of 1.24 times Price-to-Book based on reports by OCBC Investment Research.

K-REIT – Value Affirmation?
 Looking back at K-REIT, the fact that it is able to attract institutional investors like Goldman Sachs can be viewed as value affirmation and a positive outlook to S-REITs.

K-Reit currently owns the highest-quality office portfolio among office Singapore Office REITs including prime office buildings such as Ocean Financial Centre, One Raffles Quay and Marina Bay Financial Centre Towers 1 and 2 which makes up 80 percent of its portfolio by net leasable area.

With its prime portfolio, K-REIT attracted major investors such as Temasek Holdings and Capital Group which owns a 2.8 and 1.33 percent stake in Keppel-REIT respectively. This affirms the value of K-Reit and its prospect but at the same time proves the point that it seems to be be currently overvalued by investors.

Source: FactSet, table on K-REIT’s brokers’ recommendations

Investing in a Low Yield Environment
 When investing in REITs, it is important to consider the sponsor of the REITs, this particularly so after lessons learnt from the Lehman crisis. REITs with strong sponsors such as Mapletree Logistics Trust weathered through Lehman crisis despite the credit crunch. While REITs with weak sponsors such as MacarthurCook Industrial REIT(now known as AIMS AMP Capital Industrial Reit) almost went bust.

Source: FactSet. chart comparing the returns of AIMS AMP Capital Industrial REIT and Mapletree Logistics Trust (5 year horizon)

Bond ratings of a REIT is another factor to look at as it plays a huge role in the ability and cost for financing in REITs. Bond ratings and borrowing costs have an inverse relationship which means that the higher the credit rating of the company, the lower the cost of financing.

It is also favourable for REITs to obtain investment grade ratings as institutional investors like insurance companies have been constantly seeking for such bonds since the Lehman crisis as stricter risk mandates have kicked in. Having insurance companies as holders of the bonds are favourable as they tend to buy and hold to maturity which will bring stability to bond prices.

To sum up all the points, no matter how good the quality of the investment is, it will not be a good investment if you overpay.

Investors need to be prudent in picking the REITs not only in the quality of the assets but also the cost of investment. If Goldman Sachs is receiving 5 percent yield, why should retail investors settle for less?