Some REITs offer exposure to a specific real estate segment while others offer a combination to a few such as commercial (offices), hospitality (hotels, service apartments), retail (shopping malls), industrial (warehouses, factories) etc. As each real estate segment is influenced by its own demand and supply dynamics, location and outlook, investing in a REIT requires an understanding of these factors. Ultimately it is important to note that not all real estate investments are recession proof.

Use the same analysis as you would in buying a physical property when screening for a REIT.

A common measure to compare valuations of different REITs is to assess the price-to-book ratio (P/B)1. The lower the ratio, the better the value. Changes in the unit price of a REIT affect this ratio. A ratio less than 1x suggests that the REIT is undervalued. If a REIT is trading at a premium to its peers, the market may be pricing in higher-than-expected future growth. A 10% fall in the price of an overvalued REIT can wipe out the benefits of the distribution paid out over 2 years assuming an annual payout of 5%.

For a fairer comparison, select REITs in the same country and segment to determine if it is over- or undervalued.

¹ Price-to-book: Price per unit / Net asset value per unit
  Net asset value: Value of assets minus the value of liabilities on a balance sheet

Unitholders of REITs are entitled to regular distribution payouts while shareholders of listed corporations are not guaranteed dividend payouts. A dividend paying corporation can choose to vary the amount they declare as dividends at any time whereas REITs are required by law to distribute at least 90% of its income. Still, REITs are exposed to economic cycles and hence the payouts can be affected if rents fall or expenses rise, resulting in a lower net distributable income.

REITs with higher yields¹ are not necessarily better, look instead for REITs that have a track record of a consistent increase in distribution per unit (DPU) over time.

¹ Distribution Yield: Annualised DPU/ Unit price

REITs are typically debt funded as debt tends to be cheaper than equity; a rising rate environment will therefore affect the REITs’ borrowing and refinancing costs. Typically interest rates rise when inflation is high. Against such a backdrop, rental rates should rise correspondingly which in turn enables the REIT to maintain its distribution yield. Managing funding cost and maintaining a sustainable debt level1 is key in determining a REIT’s long-term investment potential.

The credit rating of a REIT reflects its overall quality. Higher-rated REITs tend to enjoy lower borrowing costs.

¹ Debt level: Total debt/EBITDA
  EBITDA: Earnings before interest, tax, depreciation & amortisation

REITs not only provide a good source of consistent income but also offer the potential for capital appreciation. Furthermore, REITs typically tend to have low correlations with other asset classes such as equities and bonds. The bulk of REITs’ returns come from their dividends whereas most of equities’ returns come from capital appreciation. REIT prices also tend to be less volatile given that their valuations are linked to the real estate sector which sees slower price fluctuations. Unlike bonds, REITs can be an inflation hedge. Bond prices and its coupons tend to be affected during bouts of inflation. REITs, on the other hand, tend to earn higher income during these times as rental rates and the underlying real estate assets values should pick up during inflation.

REITs act as a good diversifier for an equity and bond investment portfolio.