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Retail REIT: 4 Things To Look Out For
Perspective | 09 March 2015
By: Peter Ng
Articles (81) Profile

Here are the four things you must look at when evaluating a retail REIT.

1) Eliminate Backward Biasness

Typically, an analysis of a REIT’s underlying portfolio involves looking into a property’s land tenure and capitalisation rate.

However, this may not be sufficient as such statistics are backward looking and are often not an accurate depiction of the future. Therefore, paying a considerable amount of attention to forward looking aspects is equally critical and seems to be commonly lacking in an analysis.

An example would be understanding the composition of properties under a retail REIT’s portfolio in the categories of urban and suburban shopping malls, in order to dive into the spending habits of the visiting shoppers.

That is, the spending habits of shoppers in an urban and suburban shopping mall could differ in the percentage of discretionary and non-discretionary spending.

In comparison to a city-center shopping mall, a suburban shopping mall should record a higher proportion of non-discretionary spending as shoppers may be frequenting shopping malls to do grocery shopping.

As a result, tenant sales would be more resilient even in the event of an economic slowdown and in turn helps to cushion the impact on rental income during such a scenario.

2) Ability To Grow Organically Just As Important

Although not as exciting as an outright acquisition of new properties, growth through asset enhancement initiatives fulfils a different role besides enhancing yield.

The key is to keep a REIT’s underlying portfolio of properties relevant. A skilled manager is one who understands the importance of keeping its portfolio relevant in order to increase and maintain the flow of shoppers.

While higher shopper traffic may not guarantee higher sales for tenants, however, in a scenario when a shopping mall has no patronage, there will not even be a chance for tenants to make a sale.

In other words, the manager will have a higher bargaining power to negotiate for higher rental reversions for a shopping mall that enjoys a higher shopper traffic, translating into higher distributions for unitholders.

3) Quality Acquisitions And Not Just Any Acquisition

Acquisitions will most likely be ranked as the main driver of growth for most REITs. However, the essence of an acquisition lies in whether it is accretive to unitholders going forward.

This point does not relate only to retail REITs but is overall an important consideration.

Most of us would likely be familiar that the capitalisation rate of a property is derived as annual rental income as a proportion of property value.

On the numerator, rental income could be misleading at times due to factors such as income support (REIT’s sponsor covering for rental income if it does not meet a certain level) which shields the property from revealing its true rental worth.

What remains is property value at the denominator, and this measure is crucial because if a REIT is aggressive and overpays for a property, it is just a matter of time before a lower capitalisation rate is unveiled.

As a result, this will lead to a drag on the portfolio’s overall capitalisation rate which subsequently affects distributions.

The question people may ask is, why would a REIT overpay for an acquisition then? To be honest, there are numerous reasons but more often than not it revolves around pressure.

The pressure to answer to unitholders as a REIT is a listed entity after all, and even pressure from a REIT’s sponsor since a REIT functions as a vehicle for sponsors to execute their capital recycling programmes i.e. lighten their balance sheets.

4) A Mixture Of All Reduces Risk

The classification of tenants into their respective trades is known as trade mix, where the classification could reveal signs that may have a positive or negative impact on tenant sales.

A shopping mall exhibits concentration risk if its trade mix is occupied by too many retail businesses of the same trade compared to a REIT that has a well-diversified trade mix.

This means that a slowdown in a particular industry or shift in consumption patterns could significantly weaken the sales of the entire trade segment, and subsequently weigh down on the REIT’s performance.

Consider this. If a shopping mall is dominated by a large proportion of electronic goods retailers, the growth of e-commerce businesses could pose a threat to a brick-and-mortar store as consumers shift their consumption patterns to the online mediums.

In this case, an effective manager is one who strikes a balance between the risks and rewards on the choice of its tenants.

That is, some businesses may have the capacity to pay higher rentals but too much exposure to the same trade exposes the REIT to concentration risks and the implications are as what we have discussed.

The Grand Scheme Of Things

Although this may not be a complete check list for the analysis of every aspect of a retail REIT, however, the commonality involved is to pay more attention to sustainability, and especially a large proportion of a REIT’s return could be attributed to a REIT manager’s strategy and its execution.

A portfolio may be locking in wonderful capitalisation rates at one point of time, however, this does not indicate that it will be able to do the same in the future if the shopping mall is facing a continuous decline in shopper traffic or has simply too much vacant space due to a lack of demand of retail space in the complex.

Check out our very own investment blueprint of a retail REIT, CapitaMall Trust, which is the largest REIT in market capitalisation on the Singapore Exchange.
Backed by a strong interest in investments, Peter's research spans across a range of industries, with his focus placed on companies listed on the SGX.

Please click here for more information about this author.


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