REITs – BT

Can Reits weather the turbulence?

REAL estate investment trusts (Reits) have grown increasingly popular over the years due to their attractive tax-exempt dividend income and greater liquidity as compared to physical property assets.

With more people starting to plan for their retirement earlier, many look to Reits as a form of ‘annuity’ that will see them through their golden years.

Even global fund managers have now set up dividend funds to tap the rise of the dividend culture, with Asia taking centrestage.

Notably, recent times have brought about an increased trend among Reits to acquire yield-accretive overseas assets to diversify their earnings base. This acquisition trail tends to be focused more on developed countries, such as Japan, where yields are perceived to be more ‘stable’. But is this really a wise move or a lack of foresight, from a risk management angle? More importantly, are Reits really that resilient to capital downside in times of turmoil while staying capable of sustaining dividend payouts indefinitely into the future?

Let us evaluate this in the context of the latest natural disaster that has hit Japan.

When news of the recent 9.0-magnitude earthquake and tsunami hit newswires last Friday, investors scurried to sell off positions in a broad range of equities, including the once-believed safe-haven Reits.

This led Reits with income and asset exposure to Japan such as Saizen Reit, Parkway Life Reit (P-Life), Mapletree Logistics Trust (MLT), Frasers Commercial Trust and Starhill Global Reit to shed 16.1 per cent, 5.3 per cent, 4.4 per cent, 6.2 per cent and 2.4 per cent respectively since last Friday.

Some feared fluctuations in the Japanese yen may trigger translation losses for Reits. But, in the first place, the more pertinent question to ask is: is the yen more likely to appreciate or depreciate in such a scenario?

Our guess is the yen may appreciate against the greenback in the short term as Japanese investors repatriate funds back to Japan. With hefty insurance payouts also looming on the horizon, the yen could be further boosted as insurance companies quickly liquidate foreign assets to raise cash.

We borrow confidence that this trend will persist in the short term as the yen’s advance last Friday was similar to that experienced after the 1995 Kobe earthquake. As such, income impact – if any – will be more positive than negative for now.

On the asset front, overall damage was also in check as verified by most of the affected Reits. Besides, most Japanese assets tend to be insured against natural disasters. This being so, any fears arising from the need for excessive capital expenditure are probably unwarranted although insurance premiums are likely to increase going forward – an item that is unlikely to materially dent a Reit’s bottom line.

All in all, most of the Reits walked away relatively unscathed, except one: Saizen Reit. It took a hard knock as the trust’s entire asset portfolio consisting of 146 properties is located in Japan, of which 22 properties are situated in worst-hit Sendai. The lack of diversification of its earnings base sent the Reit reeling, with its units plunging a sharp 16.1 per cent or 2-1/2 cents to 13 cents since tragedy struck last Friday.

Fortunately, most of the other Reits with exposure to Japan have diversified portfolios where income streams come from a mix of geographical locations. Analysts reckon income streams for most Reits are not likely to be materially impacted going forward.

Interest rates-wise, the recent disaster that destroyed much of north-east Japan’s infrastructure is more likely to deflate interest rates than inflate them in the short to medium term as the government attempts to keep interest rates near zero while rebuilding the nation.

Our view is further supported by the Japanese central bank’s recent move to inject 15 trillion yen (S$232.4 billion) into the nation’s money markets to promote financial stability and boost overall liquidity.

Reits with debt arising from Japanese assets are therefore likely to continue operating in an ‘idyllic’ low-interest-rate environment, at least in the short to medium term.

Interest rates could, of course, become firmer in the longer term. After all, they are ruled by a function of demand and supply for funds. For instance, if infrastructural demand increases, increased competition for funds may drive up interest rates.

That said, interest rates are unlikely to be able to escalate very much before triggering government intervention as the Japanese government tends to favour less stringent monetary policies that promote liquidity in the nation’s money markets.

To highlight a couple of Reits that could potentially be affected by interest rate movements in Japan, let’s examine P-Life and MLT – the two Singapore-listed Reits with the greatest amount of Japanese borrowings within the Singapore Reit universe.

Both Reits currently still draw bullish ratings from analysts despite their debt exposure to the stricken nation. In particular, P-Life has held up exceptionally well despite a meltdown in regional markets. So far, P-Life has eased 2.4 per cent year-to-date as opposed to the benchmark Straits Times Index (STI), which has declined 7.6 per cent since the beginning of the year.

Analysts such as Janice Ding from CIMB also remain positive on both Reits’ outlook in the times ahead as reiterated by her ‘outperform’ calls on both stocks and target prices of $1.98 and $1.05 for P-Life and MLT respectively – this translates to 23 per cent and 20.7 per cent upside potential for P-Life and MLT respectively, based on yesterday’s closing prices.

So what are our key takeaways from this?

Diversification of earning streams is perhaps one of the key imperatives from a Reit’s risk perspective as reflected in the case of Saizen Reit. Even though Japan is seen as a developed nation that could provide stable yields from its assets and mature economy, too much of a good thing may be bad after all.

Reits that had other sources of income – such as P-Life and MLT – weathered this round of ‘turbulence’ much better than counterparts that did not.

In fact, sharply discounted prices make such Reits look increasingly attractive from a yield perspective. Not only are they resilient in trying times like these, they ‘fill our wallets’ on a regular basis too.