In this article I will share the three most important financial ratios when analysing and shortlisting REITs. I call them the three musketeers of REITs. The 1st musketeer’s name is Yield, he gives you money; the 2nd musketeer’s name is Gearing, he takes away your money; and the last musketeer is Price to NAV, he decides whether you are getting a good deal.
The technical terms for these three financial ratios are: Distribution Yield, Gearing Ratio and Price to NAV Ratio.
For REITs, the common technical term is distribution yield instead of dividend yield. It is very common to see Distribution Per Unit (DPU) Yield in some of the analysts’ reports.
Distribution yield is as a measure of the income you receive relative to the size of your investment. For example, an ABC-REIT trading at a price of $1.00 per unit which distributed $0.05 in distributions to unit holders in a year would have a distribution yield of 5%.
This distribution yield is a very important number because you can estimate the amount of passive income you are might receive in a year. For example, the current unit price of Lippo Malls Indonesia Retail Trust is $0.275 and the current distribution yield is 10.58%. If you invested $100,000 in Lippo Malls Indonesia Retail Trust, your annual passive income would therefore be $10,580. As long as the fundamentals of a REIT is sound and the REIT generates good rental income, the distribution pay-out should increase year over year.
The gearing ratio for real estate investment trusts is calculated by taking the gross borrowings divided by the total assets, based on the latest valuation of the REIT. The debt limit for Singapore REITs is 45%, which represent the maximum level the REIT manager can borrow to grow the DPU without issuing any new shares. It is not always good for the REIT manager to issue new shares because it causes dilution to the existing shareholders which may cause the share price to drop or DPU to drop. In addition, the existing shareholders need to inject more capital to subscribe to the new shares.
For example, currently Ascendas Hospitality Trust’s gearing ratio is 23.7%. This REIT has huge debt room before getting close to the 45% limit. Ascendas Hospitality Trust can borrow to acquire new hotels to grow the DPU without issuing any new shares.