Friday, October 10, 2008

Main points to consider when evaluating REIT and TRUSTS

I chanced upon the below in an online investing forum - WALLSTRAITS and found that it has a succinct explanation of what to look out for when evaluating REITS and TRUSTS. This is what I looked at too, though, I am not a believer of REITS and TRUSTS as I would rather buy into the parent company. Further, if you are already investing in properties, it is better not to over-allocate to REITS (even if it is different focus like office, hospital or hotels). The underlying in the REITS are still properties and it is still influenced by the property cycle.

Major factors include:
1. Borrowing Cost
2. Lease Expiry Profile
3. Credit Quality

Borrowing Cost
Those who have not locked in their borrowing costs will certainly experience problems. As forum members are probably aware, credit has tightened a great deal.

Case in point: First Ship Lease Trust was recently forced to downgrade their DPU forecast because their lenders raised the interest rate on FSLT's debt.

Lease Renewal
This depends on:

a. Lease expiry profile - the more spread out the leases, the smaller the effect of lease renewal; and

b. Existing rates being paid - if the existing rates are very low, renewing at today's rates may still result in a net increase.

Credit Quality
This has been overlooked by many people investing in REITs, shipping trusts and high-yield funds.

For example, I posted on the old forum about Babcock and Brown Structured Finance Fund (nka Babcock and Brown Global Investments) almost 2 years ago:

I warned that many of the underlying investments were of "junk" grade. Fast forward to today, and many of the underlying loans have stopped payment. People who think BBGI can maintain its forecast interim dividend rate of 3 cents i.e. 6 cents a year are being optimistic to say the least.

I could also write about Mapletree Logistics Trust and their exposure to Fu Yu, but that would double the length of this post so I'll save it for another time. Suffice to say that Fu Yu is losing money big time. If they have to vacate their building, the lease agreement isn't worth anything, and MLT will have to find another tenant - at much lower rates. MLT's exposure to Fu Yu is about 2% of total rental so it's not huge, but the fact that they have this exposure at all smacks of insufficient due diligence when buying the building.

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