All about REIT - The Basics Part 2: More about Yield

In the last posting, I have talked about the basic idea regarding DPU and yield. In this posting I shall touch on more on the topic about yield.

Do we always go for the REIT with the highest yield?
On the surface it seems that the higher the yield the better the deal. For a 10% yielding REIT, we can get back the capital from the DPU in 10 years time. For a 5% yielding REIT, it will take 20 years. So why not go the highest yielding REIT? Well if only things were that easy. As the saying goes, there is no free lunch, and so there are always reasons why a REIT has a much higher yield than its peers. In general we can say that the higher the yield the higher the risk, and so we should always do our homework well when we go for a very high yielding stock. We have to look at the reasons and decide whether we want to take the risk.

So what are some of the reasons for REITs to give a very high yield? Well the yield of a REIT is closely tied to its share price, the denominator in the yield calculation. So another way to phrase this question is what are some of the reasons for the market to view a REIT as risky and hence will only pay a lower price for it? I shall not go into details here for the time being, as this is another big topic to be covered. For a brief mention, some possible reasons could be high debt level or gearing incurred by the REIT, sector risk, country risk, etc. An example of sector risk could be during the outbreak of H1N1 when less people travelled, hospitality REITs were affected much more than REITs of other sectors. An example of country risk could be that the REIT has properties primary in a single country, and that country could be facing some political instability.

Actual Property Yield
Was pondering whether to cover this topic as it might cause confusion, but decided to briefly mention this so that the topic on yield is more complete. So far the yield mentioned in this posting is over the share price of the REIT. The actual property yield, on the other hand, is the rental income of the properties over the price of the properties. Now this is one way in which investing in a physical property is different from investing in a REIT. When we buy a private condo for say SGD 500,000, and we collect rent it out for SGD 2,000 per month, the rental yield is 4.8%. To make things simple, I have not factored in debt and interest incurred in buying the property. But when we invest in a REIT, the yield we get is not the actual rental yield, but is dependent on whether market is paying a premium or discount to the NAV (Net Asset Value) of the REIT. NAV of a REIT is its assets minus its liabilities. If the share price of a REIT is lower than its NAV, the yield over the share price we get is higher than the actual rental income yield of the physical properties of the REIT. Again this is a very simplistic way to look at it as the assets part of the NAV may not be entirely made up of physical properties. Some REITs may have stakes in a property fund or another REIT, which in turn has its own unit price.

So why should we bother about the actual physical property yield since we are paying for the share and not for the property? Well this will be a factor to consider if the REIT is acquiring a property. Usually the rental yield of the new property will be mentioned. Base on this information, we should be able to calculate the how it is going to affect the DPU yield we get, i.e. whether it is going to be yield-accretive, hence increasing the DPU we get, or otherwise.

Related Posts

• All about REIT - The Basics Part 1: DPU and Yield
• All about REIT - The Basics Part 3: Gearing
• Other articles from All about REIT