Last week, I talked about:
- bubbles, in “Let’s Talk About South African REITs. Because they do so well.” and
- how to own a shopping centre with almost no money, in “South African REITs: What Are They“
- What I’d be concerned by if I were investing in a REIT.
Firstly, here is a list of listed SA REIT members (that you can trade on the JSE): www.sareit.com. That list comes with website links to property portfolios and financials and all the good stuff.
A Word About Net Asset Value
In the time that I’ve spent thinking about REITs, and reading their financials, I have been surprised by how often the individual trust units trade at large premiums to net asset value.
Here is why that is so surprising (to me):
- If you went to go and buy a house, would you ever look at the listed price and say “Hey, let me pay a lot more than that!”
- You would not. If anything, you’d put in a lowball offer.
- Particularly if you only wanted to buy the property for investment.
- Then consider a shopping centre.
- How easy is it, really, to sell a shopping centre?
- Not easy.
- Mainly because the only people that would be in the business of buying shopping centres are other investment managers from other REITs.
- And their main interest would be the income-generating capacity of said shopping centre (ie. how much is the rental yield relative to the capital investment?).
- The capital appreciation…would come from the growth in rentals over time (the capital value is how much someone would pay to own that property – and if everyone that would buy the property would be basing their valuation on rentals – then the whole thing is basically a function of rental income).
- Also, in most REITs, the properties in the portfolio are revalued each year to market value – and that market value is based on…rental income models.
- So everything in the REIT is kind of already fully valued.
- If anything, maybe a bit overvalued. After all, assets tend not to trade at their full market value, because value is not the same thing as price, and if you were going to sell a property that large, then it must be for a reason, which means that you’re open to negotiation.
I guess there would be some fluctuation around Net Asset Value during the year – because revaluations of property would only take place intermittently. But still – when it comes to large properties, rentals tend to be fixed by long-term lease contracts.
And you could also say that there is some premium attached to properties under development (where the full value of the property can only be realised once the properties are completed).
But still – I’d be cautious of large premiums to net asset value. There is a kind of circular referencing taking place that makes me uncomfortable – income driving property valuations driving income…
Property As A Business
- You have a property.
- You rent it out to tenants.
- You incur maintenance costs and insurance and rates and such.
Based on that, you’d have some concerns:
- Regarding tenants:
- Who are these tenants (credit quality, reliability, etc)?
- What are they using the premises for (retail, business, factory, government use, etc)?
- What type of leases are they signing (long or short term, escalation clauses, etc)?
- How likely is it that they’ll move (are they growing rapidly, are they in decline)?
- Regarding operating costs:
- How high are they?
- Who are the main contractors being used?
- Is there sufficient maintenance take place?
I don’t think that a REIT evaluation is any different.
So Let Me Use Delta Property Fund (DLT:SJ) as an example
Some charts and things from Bloomberg:
Alright. So looking at that, some observations:
- The shares are trading at a 24% premium to net asset value, if you look at the price to book ratio of 1.24.
- Even though everyone seems to be expecting worse earnings (look at the estimated P/E ratio of 10.8 versus the current P/E ratio of 7.5).
[An Updated Note: so, if you read this post a number of times yesterday, you may have noticed that my math was all over the place, and I fluctuated between discounts and premiums and better earnings and worse earnings like I was high. After the fourth update, I realised that I was having a Windows day, and it was best to wait for the ctrl+alt+del of morning before I tried again. Here are my thoughts today:
- There is something weird going on between Bloomberg and the Delta Fund Financials.
- According to Bloomberg, the price-to-book ratio is 1.24 – which implies that the book value per linked unit is R6.45 (and this would have been the last book value given out in an official results release, possibly adjusted for any distributions and new share issues).
- In the latest Delta Fund financials, the book value per linked unit is given as R8.87 – implying that the price-to-book ratio is 0.902, and that these shares are trading at a discount.
- Based on my rough calculations – if the market cap is 3,608 million, and the NAV was 3,262 million – then the price to book ratio is 1.106. And if you include debentures as part of NAV (which one should – as these are linked units), then the NAV was 3,812 million and the price to book ratio is 0.95.
- That said – it’s been a long time since February, so it’s possible (even probable) that in the interim, new distributions have been made and new linked units issued.
- Make of that what you will. My gut tells me that almost no one is right – because we’re 6 months into the financial year, and the NAV will have changed.]
So assuming that my interest is now piqued, I would then go and have a look at their website. And I would start by looking at these graphs:
Then I’d go and look at the financials from 2014:
And I’d wonder whether operating expenses of 23% of rental income were normal or not…
This would require some more digging (in which I’d discover that Growthpoint Properties have an operating expense that’s 33% of rental income!).
And then I’d remind myself that I prefer government offices to shopping centres because of all the empty stores in Cresta and Sandton and Hyde Park Corner… But again – perhaps that’s just me.
And if I did decide to buy some units…
Two ways about it:
- Call my stockbroker; or
- Sign up for FNB investor.
Hope that helps!
Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.
Kosta September 9, 2014 at 12:14
Thanks for this series on REITs Jayson, my friends and I are really enjoying it. Looking forward to your thoughts on investing in 100% equity funds vs REITs. I’m primarily curious as to the benefits of REITs from the perspective of generating an income stream. Can they for example pay us monthly dividend yields over and above their capital appreciation (thus simulating physical ownership of a property without all the associated admin). Also curious about the tax implications of earning income from a REIT (I suspect this wouldn’t constitue as capital gains, but rather as standard taxable income that gets added to our existing income?). One of your famous straight-up long-term performance analyses comparing the two would also be interesting. Because I’m still sitting firmly in the 100% equity camp at this stage.Reply
Cabanga September 9, 2014 at 19:35
Great post(s) Jayson. Just a note, you say “The shares are trading at a 20% discount to net asset value (look at the price to book ratio of 1.24).” This is actually a premium, not a discount, because the price is 124% of the book (net asset) value.Reply
Jayson September 10, 2014 at 07:23
Thanks! I’ve been backwards and forwards with this section. When I first posted, I said it was trading at a 24% premium – then it was pointed out to me that the Delta Fund financials made it look like there was a discount – so I quickly updated the post in between meetings without really thinking about it – and then it turned into a conversation about whether or not to include debentures – and it seems like the jury is still out! But I agree that, based on Bloomberg’s numbers, we’re talking about a 24% premium to NAV. I’m hoping that it’s now updated, with a note 🙂Reply
Cabanga September 10, 2014 at 23:09
The debenture is convertible into equity so the liability will extinguish which is why you must include the value of the debentures in your calculation of NAV. As at 28 Feb 2014 the NAV was therefore R8.87 per share, and therefore based on a price of R8.87, the discount to NAV is about 13%.Reply
Jayson September 11, 2014 at 07:00
I totally agree that the debentures need to be included as part of equity. After all, we’re talking about linked units here (and the units are linked to said debentures). That said, I still think that there is something more at play. Firstly, we don’t know if Bloomberg is or isn’t taking into account the debentures (although by the look of it – probs not). But even if they are, you don’t get back to a p/b ratio of 1.24 if you exclude the debentures.
My personal view? Everyone is a bit wrong. To use NAV of R8.87 per linked unit half-a-year on seems crazy to me – I’m pretty sure that issues and distributions have happened in the interim (to say nothing of profits). At the same time, I doubt that Bloomberg pays very much attention to their ratios on small caps. It seems more of a “oh well, if we’re collecting the data anyway, may as well toss in some excel formulas, amirite?” decision than anything else.
But thanks for clarifying! 🙂Reply