How To Invest In REITs For Passive Income - THE 5 SECRETS - YouTube

Hi everyone, welcome back to The Fifth Person video training series.

My name is Rusmin and I’m the Co-founder of The Fifth Person.

Singapore’s top investing portal. In the last video, we cover why you

should invest in REITs if you want to build a steady stream of passive income.

You can check out the video here.

And in this video, I'm going to cover 5 important metrics when it comes to analyzing REITs.

After this video, you can use this 5 checklist to help you differentiate a good REIT and a bad REIT.

This is important because that's how you make money in the stock market.

When you buy and invest in a good REITs,

it will help you get more and more dividends year after year,

at the same time, you may get to enjoy some decent capital gain as well.

So if you're ready, let's go…

The first metric is property yield. I'm going to bring back the example of investing in physical property,

which I believe a lot of us have some experience in when it comes to investing in physical properties.

If not, don't worry too because I'm going to teach everything from scratch here.

So let's assume you own a physical property. When you own a physical property lease it out, you collect rental income.

This rental income, at the end of the day, we'll have to minus off any expenses that was incurred in the particular year

that you leased out to someone else.

At the end of the year,

you will have your net rental income.

So if you were to buy a property that cost you about $1 million,

and if you collect a net rental income of $50,000 in that particular year,

your net rental yield is about five percent.

This is what most people know, and I usually call

it net rental yield if you buy investment property either under our own name or our spouse name.

Okay. this is how most people will interpret and they will usually ask what is the net rental yield

for that property, this property and so on and so forth.

Ok, so REITs, or Real Estate Investment Trusts, it’s exactly the same

but instead of calling it net rental yield, we call it

as property yield, and how REITs actually classify this term in their balance sheet

or income statement is like this…

They term it as gross revenue instead of rental income.

So gross revenue is the rental income across all the properties in the portfolio. When you minus off

all the expenses incurred in the particular year,

you will have your net property income.

So your net rental under your personal property is the same as a REIT’s net property income.

and when you take the net property income divided by the property valuation,

you will get your property yield.

In other words, it’s the same definition except that its a different terminology used by the accountant.

Okay. So if you were to look at one example on how we can calculate

the property you of a REIT in Singapore,

Let's take a look at Frasers CentrePoint Trust.

It is a REIT that is listed here in Singapore.

This REIT focuses on malls and if you go to their income statement or statements or total return,

you can see that they actually have this gross revenue, which is basically the

rental income that's collected across all the properties they have in their portfolio

and that's actually equivalent to $182 million (approximately)…

and they actually incurred expenses of $52 million running these properties over throughout the year.

At the end of the year, they actually collected a total net property income of $129 million.

If you were to calculate their net property yield, or property yield of Frasers Centrepoint,

you can take $129 million divided by $2.6 billion

and that's going to give you a property yield of 4.9 percent and in 2016,

If you were to go back to 2016, 2015 and you calculate and track

using the same method and the same process, the yield is about 5.2 percent in 2016.

So when you calculate the property yield, it’s basically telling you what is the property yield of that REIT

for all the assets that they hold in their portfolio.

The higher, the better.

Then again, it depends on kind of REITs it is.

If you invest in industrial properties, your yield is generally higher because the leases are much shorter.

If you invest in office properties in Singapore,

your yield may be slightly less, at about 4.5 percent to 4 percent.

For malls REIT in Singapore, generally, the property yield is about 5% to 5.5%. As long as this figure is stable within this range...

your job as an investor is to make sure that this yield is stable

and is consistent. If the you noticed that the yield is dropping, say from 4% to 3.5%, to 3%..

It means to say that either the property valuation have gone up

or the net property income has actually came down.

This is something you have to ask management…

like.. Why is that happening?

But most of the time and in most cases, the property yield across certain REITs,

they usually have a very consistent figure.

It is your job as an investor to make sure that this vehicle is consistent.

If not, you have to check with the managers.

If you manage to find a REIT that have a very similar profile, but have a higher property yield

than the one that you actually analyzing, then that actually give you a lot questions

on the property valuation

because the lower the property yield, the more aggressive the managers (in terms of property valuation).

So a good comparison for Frasers Centrepoint would be Capitaland Mall

because these 2 REITs are mall’ REITs.

They have very similar profile and most of their properties are in Singapore.

So their property yield should more or less be the same, which is currently the case.

For Capitaland Mall Trust, their property yield is also about 5.2%, 5.3%

while for Frasers Centrepoint, its about 5%.

Okay. So currently, this is not something that is worrying. But if one day, Frasers Centrepoint’s property yield

drop to less than 3.5% versus Capitaland Mall where they're still valued above the 5.5%, then that actually give you a

lot of question marks, you need to ask the managers why are they so aggressive with their property valuation.

At this moment, there's no good examples to show you

but basically, monitor the property yield, make sure it's consistent

and make sure that it is almost on par within the same industry standard.

There is another term that some people use to refer this property yield as, and that is the capitalization rate (cap rate).

They are the same. The second metric that you need to know, is Cost of Debt.

This is basically the borrowing cost.

If you buy a property for $1 million, and you came out with cash of $400,000

and you took a loan from the bank for $600,000, you need to pay interest on that loan.

So interest rate for this example is 3%. In REITs, this is usually known as Cost of Debt.

Basically, we want to find out what is the cost of debt for that particular REIT, like how much interest they're paying the bank

for the money they borrow. This is the Cost of Debt between different REITs.

I’m going to give you 3 examples here,

Capitaland Mall trust, the cost of debt is about 3.2%

and Sabana REIT is about 4.2%

ParkwayLife REIT is about 1.4%.

As you can see, Parkwaylife Reit is basically a healthcare Reit

and they run their own hospital assets

and generally, bankers also know that hospitals are usually more stable and

they are willing to give out this loan at a lower interest rate.

Whereas for Sabana, which is an industrial Reit,

And because industrial rental prices can go up and down and this will be viewed

as a relatively risker as compared to malls and also the health care assets. That's why the cost of debt is generally higher.

So the cost of debt across different type of Reits will have a different range.

There really is no rule of thumb when it comes to the cost of debt because it depends on the interest rate environment.

If you are in an environment where interest rates are very high, the cost of debt can be very high.

As of now 2018, the interest rate for Singapore is relatively low,

that’s why the cost of debt is fluctuating at about 3% to 4%

and for good REITs like Parkwaylife, it is only at 1.5% or 2%.

So from the interest rate or the cost of debt itself,

we can tell the profile of certain Reits.

So like for REITs that have a lower cost of debt,

you know that from their profile, they actually carry less risk.

As for Sabana, the risk is definitely much higher,

so the cost of debt can give you a good indication whether the REIT is volatile or not.

So this is a very good ratio that I usually will look at.

The third important metric that you need to know is of course, the gearing ratio.

This is where you assess whether the REITs are taking excessive loans from the banks

REITs can get into a lot of trouble when they take on too much debt.

So how do you calculate the gearing ratio? Basically, If you buy a property for $1 million,

and you came out a cash of $400,000 and the rest of money is via loans from the bank,

This mean to say that your gearing ratio is actually 60%.

So if you buy a property on a personal level,

usually the bank will say loan to valuation and they're going to give you a 60% loan to valuation ratio,

but for REITs, usually we call it gearing ratio. Gearing ratio implies the same thing...

total bank loan over asset valuation.

So in this case, the given ratio is 60%.

Again, it's just a different terminology,

so don't get frightened by all these ratios.

They are very simple and once you know it, once you’ve learned it,

Basically it stays with you forever.

REITs in Singapore are tightly regulated and they are only allowed to borrow up to 45 percent of their total assets.

Meaning to say that they are not like us who can invest property and we can borrow up to 70%, 80% for private properties,

but for REITs, they can only borrow up to 45% of their assets.

In other words, they are much more conservative as compared to a lot of people who buy physical properties in Singapore

whom also took on a lot of debts.

For Reits, government actually stated that they need curb their borrowings to not more than 45%.

This also give us a very good reason why we should invest in REITs

as they are relatively safer as compared to you taking a lot of loans from the bank.

Gearing ratio can be easily calculated, and sometimes, it is given to you by the company or the business itself.

You can actually find the gearing ratio in an annual report. If not, you can easily calculate based on their

total bank loans that the REITs have over the total assets that they have.

Okay, In the case of Capitaland Mall Trust, their gearing ratio is 35%

Sabana REIT is about 43%, And Parkwaylife REIT is about 36%.

As a rule of thumb, I do not like REITs that have a gearing ratio of more than 40%. I like to have some buffer

of 5% so that it doesn't hit the regulation limits.

You can see Sabana is more aggressive when it comes to taking on debt

whereas Capitaland Mall and Parkwaylife are more conservative when it comes to taking on debt.

The fourth metric you need to know is the price-to-book ratio.

Let’s visit the same example

of owning a physical property of $1 million. If you came out with $400,000 take on a bank loan of $600,000,

your equity value is basically $400,000.

So in the context of REITs, they call it equity.

So the equity is $400,000, which is everything cash by yourself.

And then you have loans from the bank, which is usually captured under liabilities.

They call it bank loans, which is about $600,000 and then you have a total asset of $1 million.

So again, they mean the same thing but using different terminology.

So don't get frightened by that.

How to get the book value is very simple.

You take the equity value divided by the number of shares outstanding or in which we call it units,

You get your book value. Okay.

So how do you calculate your Price to Book ratio?

Basically, you take the price divided by the book,

in other words, share price over Book value and that's where you get the price to book ratio.

How do you interpret Price to Book ratio is very simple.

If the company or REITs has a Price to Book ratio of 1,

theoretically, it says that the company is trading at a fair valuation.

It means to say that if the company, their asset is worth $1.

or the book value is worth $1, the market is also selling

and buying at $1. We know that it's fair valuation because their asset is worth $1 and it’s also being traded at $1.

This is based on theory.

If its 0.5 times of the price-to-book, meaning to say that is undervalue.

Meaning to say that the assets, the net asset value or book value is $1

and market is actually selling or buying it at $0.50.

So this is quite an obvious case where price to book of 0.5 is undervalue. Meaning to say that we also want to buy when the price to book is 0.5.

Of course this is based on theory.

I just wanted to explain to you the theory first and then warn you

what is the setback of this ratio…

If it's like 1.3 times, mean to say that this particular piece of asset is worth one dollar,

but the market is willing to buy or sell at $1.30.

This means to say that the market is over paying above the valuation.

Okay, of course, this doesn't make sense. So based on theory we always want to buy here and sell here.

But in practice, this doesn't always happen

because in REITs, or real estate investment trust, the way the asset is being valued can be very subjective.

It's a very gray area and every independent valuer will have a different price tag for the different type of properties.

So a lot of people may come to different conclusions.

At the end of the day, Reits trading at 0.5 to book or 1.3 doesn't say a lot ifthe REITs is undervalued or overvalued,

So this is something I wanted to warn you

because a lot of people make the same mistake over and over again when they start to invest in REITs.

One of the first metrics that they look at is the Price to Book ratio. They want to buy REITs that is trading at below 1

and then hopefully, sell it when it's above 1.

It doesn't work that way but I just want to warn you in this video.

So don't use price-to-book alone to make investment decisions.

This is a very very important reminder that I want you to know in this video

and also the second most common mistake that people make is of course, the fifth metric

and that is, the division yield.

When you first started investing, many times,

I hear people saying “Oh, this REIT is paying 5% yield… Oh this one is better because it's giving a yield of 6%, or even better at 9%”

A lot of times people make decisions based on the yield alone.

So you have REITs that gives you 6% yield and you call it decent, and if its 4%

Its low yield and not attractive. If the REIT can give a 8 - 9%.

Wow, that is very attractive…and we should invest in this kind of REITs. It can be very

dangerous if you were to make decisions based on yield alone.

We all know that there are different types of REITs in the market.

You have healthcare Reits, you have malls, you have office,

you have industrial, you have hotels which is under hospitality

and different types of REITs will have different risk profile and when it come with different risk profile,

you will have a different dividend yield.

That's why I want to warn you in this video that you do not buy a REIT

solely based on The Price to Book ratio or the Dividend yield.

This is a very important point to take note of.

By now, you should have learned a lot of insights about REITs and the five important metrics to analyze them.

They are property yield, cost of debt, gearing ratio, price the book, and dividend yield.

I personally use these metrics myself

and when it comes to analyzing REITs in Singapore and Malaysia,

so far… they have worked very well for me.

I hope you’ve enjoyed this video

and if you're interested to learn more about building passive income with REITs and Dividend stocks,

we have a coaching program where we will show you how to find the best dividend stocks and REITs

in Singapore and Malaysia. You can find our coaching program at Dividendmachines.com.

and as a bonus for completing this video, we have actually compiled a list of Singapore REITs that

have been increasing their DPU or distribution per unit year after year.

You can download this list completely free.

You can find the download link in the description box below.

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Thanks for watching and I'll see you in the next video.