To The Moon

I am sure many of you want to know what is a good entry price of a stock (specifically REITs). You might hear some people say that this REIT is so undervalued that you should buy immediately whereas others might say can wait for it to drop a bit more before entering, and there will be someone else who say the same REIT is ridiculously overvalued that he/she is not touching it until it drops another 20%.

So.. who is right? Who should you listen to? Or most important of all, how to decide for yourself if you should buy or not?

In this post, I will attempt to give some clarity and hopefully you can get more conviction into the REITs you are buying.

Disclaimer: I am a small time retail investor. I am not an expert in REITs or any valuation methods. All the methods I discussed in this post are based on my understanding only. If you see any mistakes or have a better method to do valuation for REITS, please feel free to drop a comment so we can all learn from each other. Thanks!!

REITs and its peculiarity

REITs (Real Estate Investment Trusts) are entities that own, and/or manages income-producing real estate. REITs are asset heavy, meaning most of their capital is in the form of properties. They are also required to pay out 90% of their income to shareholders.

My personal take on REITS: I would go for REITS which invest directly in properties as it is easier to value and has a simplier structure. I hold REITs mainly for its dividends payout. Capital appreciation is secondary as long as dividends payout is consistent.

Valuation methodology I use for REITs

There are many different valuation methodology used by many experts, from Price to Earnings, Price to Sales, Price to Book value, Dividends yield, Enterprise Value to Earnings, discounted cash flow etc...

For REITs, I am only interested in the dividends, so the first method I will use is the dividends payout to determine whether the REIT is over or undervalued.

Note that this method I am introducing uses past data, so they can only tell the story until present time. This is a quick method to determine if the REIT is over or undervalued now. However, past performance is no guarantee that it will perform the same in future.

In order to know the future, I will also consider other factors, such as who is the sponsor of the REIT, management team and direction, what is in the acquisition pipeline, property type and location, occupation rate and tenants mix, WALE (Weighted Average Lease Expiry), and gearing ratio. There are many good articles out there discussing and comparing these factors. I am by no means an expert, so do your own due diligence and read up on the REITs you are interested in.

The second method I will use to complement the dividends payout valuation is price to book value ratio (also known as PB ratio). The reason why I use PB ratio is because REITS are asset heavy. Book value can be thought of as net asset value (NAV). This metric will allow one to understand how much the total asset is worth after subtracting all the debts and expenses. In the event that the REIT is liquidated, this number will tell us how much each share will be worth and potentially how much you can get back.

Using Dividends Payout method to perform valuation

The dividend yield is computed by taking the distribution per unit (DPU), typically published in the financial statement of the REIT, divided by the share price. If you are already holding onto the shares of the REITS, you do not even have to read the financial statement, you just need to take the total dividends payout for the entire year divided by the number of shares you are holding to know the DPU.

For example, the DPU for Mapletree Logistic Trust for the year 2021 is $0.093. Taking a share price of $1.75, the dividend yield is ($0.093 / $1.75 = 5.31%). Taking into account the strength of the REIT and its sponsor, the management team and the other factors mentioned above, i will accept a dividend yield of 5% and above, so MLT at a price of $1.75 a share is considered fair to slightly undervalued to me.

Note that there are 2 parts to the equation, the DPU and the share price. The DPU is decided by the REIT manager. We, as a retail investor, has no say in the DPU. The only thing we can "change" is the share price. When i say change, what i mean is we can decide when is a good time to buy and when we should sell.

Therefore, for someone who is more conservative and want a 6% dividend yield, we can then calculate what is considered fair value for 6% dividend yield by using this formula: (DPU per annum / 6%). Using the above example, the share price will have to be $1.55 for the dividend yield to hit 6%. Therefore, for this person, a share price of $1.75 is overvalued.

For another person who is happy with a 4% dividend yield, the fair value will be (DPU per annum / 4%), which will be $2.33. Therefore a share price of $1.75 is grossly undervalued now and he/she will be buying immediately.

Notice that depending on your risk appetite and desired returns, you will arrive at a different entry price. And there is no wrong answer! The question you should ask yourself is.. What is the rate of returns you are happy with and are you ok with the risk and reward you are getting?

For me, if the REIT dividend payout is unstable, I would give a "haircut" to its valuation. So if the dividend yield fluctuates between 3% to 5%, I will assume the average yield of 4%. Therefore, in order to meet my minimum criteria of 5% dividend yield for this example, I have to add 1% more to the average yield to ensure that i will get 5% average yield. This means that for this example, I can only accept 6% dividend yield, which translates to an entry share price of $1.55, so in the event that after I buy, the dividend payout drops by 1%, I can still fulfil the 5% yield because my share price is lower. This is the "margin of safety".

Using PB Ratio for valuation

For PB ratio, one can google for the book value per share of the REIT. Then you take the share price divided by the book value per share.

The book value is the net asset value of the REIT. In simplier terms, it means that if everything in the company is sold off, each share will be worth approximately this amount.

For this example, the book value is $1.42. If we take the share price of ($1.75 / $1.42 = 1.23). Note that this is a ratio. This means that for every dollar worth in the REIT, i will pay $1.23 dollars for it. This is acceptable for a strong REIT which is not likely to go belly up. For weaker REITS, the ratio will be lower. For high growth REITs such as DC REITs, it is acceptable to be a bit higher due to the amount of revenue it will be bringing in.. So the PB ratio can go up to 2. ‌
‌@TigerStars‌