REITs - CAP RATE, Gearing, Asset Value and Interest Rate movement

[WindBoi]

A blogger came up with quite a good article on this subject at the right time.

There are certain stocks that are most sensitive to interest rates and probably non more so then stocks which provides low growth (1-2%) and high yield.

The effect is that most would think that only rentals will be affected but its far more than that.

Remember that loans are made with covernants against EBITDA and Asset Valuation.

Your REIT may look save with a 30% debt to asset. Your loan is against your asset valuation.

With a low interest rate the market don't really demand that high of a required return. A move down in CAP RATE, results in higher Asset Value, and your reit will look pretty safe at 30% debt to asset.

conversely, when the hurdle interest rate approaches 3% for SGS 10 year, the risk to bear a REIT investment would have to go up from 6% to 7%. When the CAP RATE Climbs 1%, your asset valuation will consequently fall by 12%.

When book value falls, so does your share price.

To rid or to reit? — MOSI

 

[prophetjul]

interesting

Part 2: Cap rate compression/expansion

FCT FY12: Portfolio valued at $1.816b with a Weighted cap rate of 5.54%. On the way down, it's great. By reducing the cap rate of Northpoint by just 15 bps, there was a gain of $36m in 2012. If, for whatever reason, holding everything else constant, the cap rate increases to 6% (an increase of 46bps), you see a negative valuation surplus of $138 million.

It is just financial engineering. Check the cap rates of ALL the reits over the past 3 years and see how much the assets have been revaluated due to a 'smaller base' effect.

Anyone can explain the relationship between valuation ans Cap rates?

 

[lzydata]

A blogger came up with quite a good article on this subject at the right time.

What I find interesting is not that some blogger came up with a post about cap rates "at the right time". It is that when REITs were going up and up, a committed REIT shortist like you was very quiet. But the moment there is a correction, now you are back with your long-running "why REITs suck" series.

 

[lzydata]

Now for the substantive stuff.

FCT FY12: Portfolio valued at $1.816b with a Weighted cap rate of 5.54%. On the way down, it's great. By reducing the cap rate of Northpoint by just 15 bps, there was a gain of $36m in 2012. If, for whatever reason, holding everything else constant, the cap rate increases to 6% (an increase of 46bps), you see a negative valuation surplus of $138 million.

This specific case is Northpoint's revaluation from $534.1m to $570.0m in Sep 2012 based on cap rates of 5.65% and 5.50% respectively. If we go back further, Northpoint's cap rate was an even higher 5.75% in Sep 2009-2011. In the Oct 2008 presentation, when Northpoint was undergoing an AEI, "based on manager's estimate of stabilised post AEI NPI of S$18m, projected property yield will be 6.3%." If we go back to the Sep 2007 valuation, the property yield is 5.46%.

And here's the kicker. What was Northpoint's cap rate assumed by its two valuers in Dec 2005, for FCT's IPO in mid-2006? 5.50% and 5.75%.

If you assume that when interest rates go up then cap rates must go up too, why was Northpoint's cap rate in 2005-6 about the same as today when interest rates in 2005-6 were much higher? Why should the cap rate rise 1% when interest rates rise 1%? Bear in mind, cap rates and interest rates are different things. I do not know, but anyone like TS who is so kindly highlighting this critique to us should have an answer.

The evidence suggests that there is not a simple one-to-one correlation between interest rate movements and cap rate changes. Northpoint's might well have more to do with its AEI in 2008-9. Its cap rate is roughly back to where it was in 2005-7, but its valuation is far greater, more than double ($265.8m -> $570m), because its NPI is also far greater as a result of the AEI.

Another bunch of data points to consider. The cap rates assumed by valuers also take into account market yields for similar properties. Looking at CMT's portfolio valuations and NPI for each mall over the years, their actual yields have been about 5% to 5.9% from 2005 to 2012. CMT started reporting their valuers' assumed cap rates from the 2008 annual report, and there have been some changes over the years e.g. Raffles City retail was 5.50% in 2008, 5.60% in 2009, 5.50% in 2010, and 5.40% in 2011 and 2012. The highest cap rate in CMT's portfolio is the warehouse segment for IMM - 7.75% in 2008, 7.85% in 2009-10, then back to 7.75% in 2011-2. The overall portfolio has a cap rate of 5+%.

Of course when interest rates normalise, REITs - just like any company or individual who has debt - will experience higher borrowing costs. Cap rates will probably go up too. But there is no basis to pluck a number like 6% out of the air and assume that disaster will loom. Historically it was never that high, and Northpoint failed to fail

It certainly does not follow, as the blogger goes on to say, that REITs must go all out to maintain their valuations by jacking up rent to an unsustainable degree. Valuations did fall during the GFC and some REITs ran into trouble with their gearing and refinancing, but that is the old story everyone already knows by heart.

In short, another unconvincing installment of "why REITs suck".

 

[prophetjul]

windboi

guess you have to initiate a reply to Izy, otherwise you are just a troll.

 

[Paul Lee]

wow.. this thread is the silent blockbuster that everyone seems to overlook (given the low view page)

Looks like the Summer Blockbuster season is in full swing.

*Pass the popcorn*

 

[Sinkie]

windboi

guess you have to initiate a reply to Izy, otherwise you are just a troll.

Now you look like a troll more than windboi

 

[sunrocker]

Now for the substantive stuff.


If you assume that when interest rates go up then cap rates must go up too, why was Northpoint's cap rate in 2005-6 about the same as today when interest rates in 2005-6 were much higher? Why should the cap rate rise 1% when interest rates rise 1%? Bear in mind, cap rates and interest rates are different things. I do not know, but anyone like TS who is so kindly highlighting this critique to us should have an answer.

In short, another unconvincing installment of "why REITs suck".

I think what TS states is true to a certain extent?

Lets say I have a pte ppty with a cap rate of 5% with valuation of $1M (with a mortgage loan). Now I/R has gone up by 1%, theoretically my cap rate will be down by 1% because now my mortage loan repayment has increase causing my cap rate to decrease. As the owner I want to keep my cap rate at 5% thus increasing rent, but rent has been so high already which I cannot increase it to keep my cap rate constant so I have to suck it up with decrease of cap rate.

Am I on the right track? Please correct me if I am wrong in anyway, I'm still learning.

(Vested in FCT!)

 

[prophetjul]

Now you look like a troll more than windboi

Just cause you said so?

 

[Sinkie]

Just cause you said so?

Bro, people offers a proposition for a proper discussion, but here you are saying people is trolling if he doesn't reply to bro lzy debation?

In the first place, do u actually understand what bro lzy data says or not?

This is not edmw so let's just sit down at the sideline together and jiak popcorn with Paul and watch the discussion evolve with substance and not stir sai to become flaming battle.

No matter who win, we will still learn and dabao home some new knowledge to make our next investment better?

 

[prophetjul]

Bro, people offers a proposition for a proper discussion, but here you are saying people is trolling if he doesn't reply to bro lzy debation?

In the first place, do u actually understand what bro lzy data says or not?

This is not edmw so let's just sit down at the sideline together and jiak popcorn with Paul and watch the discussion evolve with substance and not stir sai to become flaming battle.

No matter who win, we will still learn and dabao home some new knowledge to make our next investment better?

He trolling since he seems to be forever insinuating "Reits suck".

So does Izy response not deserve a respond.

No I am not good enough to respond thereby I asked

Anyone can explain the relationship between valuation and Cap rates?

 

[Sinkie]

He trolling since he seems to be forever insinuating "Reits suck".

So does Izy response not deserve a respond.

No I am not good enough to respond thereby I asked

Anyone can explain the relationship between valuation and Cap rates?

you are vested with reits, so people say reits sucks = people trolling, then dividend warrior better dont sell his reits, else also become troller

 

[Paul Lee]

you are vested with reits, so people say reits sucks = people trolling, then dividend warrior better dont sell his reits, else also become troller

OMG! I've sold some of my REITs (some time back), does that make me a troll too?

 

[Dividends Warrior]

Since this thread already escalated, I shall chip in too.

'Troll' is probably not an accurate word to use here.

I would not call Windboi a troll.

I would call him a 'skeptic'.

All of us are guilty of being skeptical of various investments.

For example, I am highly skeptical of S-Chips. Paul is skeptical of business trusts (especially Australian ones )

Not only REITs, even blue chips like telcos also have an their own skeptics.

Warren Buffett is known to be skeptical about tech companies too.

It is only a matter of how extreme you take your skepticism. Windboi is not that extreme yet la.......

 

[Paul Lee]

I would not call Windboi a troll.

I would call him a 'skeptic'.

For example, I am highly skeptical of S-Chips. Paul is skeptical of business trusts (especially Australian ones )

That's not quite accurate. A skeptic is one who remain unconvinced about the merits of the product/company/asset class etc. So he would not buy into the company. So calling yourself an S-chips skeptic is correct; because you dun buy S-Chips. You are also a Hospitality REIT/Trust skeptic.

In the case of business trusts and Australian fund managers (not necessary just business trust), I like to refer to myself as an reconvert (I have a better term in mind but the religious overtones is probably not worth using in a public forum)

So what's a reconvert? When you believe in the company or asset class and buy into it wholeheartedly, you are a convert. When those investment dun pan out, you become disillusioned, you sell them off and swore them off. You become a reconvert. Make sense?

So you see, in the case of Windboi/Dizzit, he's is definitely not a REIT skeptic. I dun even think he's a reconvert. He has A-REIT, First REIT, AIMS, MLT, FCT. Would a skeptic or a reconvert own so many REITs? You decide.

 

[Darkzi0n]

maybe kind of off topic...

but im reading a book on psychology... most ppl based their opinion on wat they alr believed in.. they will seek information that confirm wat they believed while ignoring information that challenge their beliefs.

The fact that windboi is holding onto so many REITs while being so skeptical about it perhaps demonstrated his ability to make rational and objective analysis?

 

[Paul Lee]

In case any of you are wondering why he is remaining quiet, lets be clear about one thing. He is reading the posts but he is choosing not to respond to it.

Pls refer to his beautiful illustration on his blog:

Why share price correct down on REITs and Trusts on interest rate rises

 

[princessreiko]

In case any of you are wondering why he is remaining quiet, lets be clear about one thing. He is reading the posts but he is choosing not to respond to it.

Pls refer to his beautiful illustration on his blog:

Why share price correct down on REITs and Trusts on interest rate rises

OMG, windboi is Drizzt?
I really like his blog!

 

[Paul Lee]

OMG, windboi is Drizzt?
I really like his blog!

Yes he is. So are you now going to bow down and prostrate before him?

It is still not too late to repent! For the end is near!

 

[Dividends Warrior]

maybe kind of off topic...

but im reading a book on psychology... most ppl based their opinion on wat they alr believed in.. they will seek information that confirm wat they believed while ignoring information that challenge their beliefs.

The fact that windboi is holding onto so many REITs while being so skeptical about it perhaps demonstrated his ability to make rational and objective analysis?

U made a good point.