3 Key REIT Indicators You Need To Monitor To Be Profitable

Updated: Dec 12

While REITs are a popular choice for generating passive income, they are not "set-and-forget" investments. To ensure both the stability of your dividends and the preservation of your capital, it’s crucial to monitor the ongoing performance of your REIT holdings.

Here are three key indicators every REIT investor should keep a close eye on if you want to stay profitable in the long run.

1. Occupancy Rate

The occupancy rate is a critical metric in REIT analysis as it directly impacts the REIT’s top-line rental revenue, which in turn influences the stability of the REIT’s distributions to investors.

A high and stable occupancy rate suggests that the REIT’s properties are consistently generating rental income, contributing to predictable and steady cash flows. This is especially important for income-seeking investors, as it ensures the reliability of dividend payments.

Why It Matters:

Steady Revenue Stream: A REIT with a high occupancy rate is likely to enjoy stable rental income, reducing the risk of fluctuations in dividend distributions.
Market Confidence: High occupancy rates often reflect a REIT’s ability to attract and retain quality tenants, indicating strong demand for its properties. This has a direct effect on the valuation of the properties, thus influencing the REIT's capacity to refinance its debts upon maturity.

That said, a lower-than-average occupancy rate isn’t always an immediate red flag. In some cases, the decline may be temporary and rooted in short-term factors, such as asset enhancement initiatives, tenant transitions, or external market conditions.

If the cause of the low occupancy is expected to reverse, this could present a buying opportunity for savvy investors. Depressed valuations due to temporarily lower occupancy may offer the potential for significant upside as occupancy rebounds and distributions improve.

However, in the case where a REIT suffers from a persistent lower-than-average occupancy rate, investors should perhaps take this as a sign to re-evaluate their position in the REITs to avoid suffering from capital losses due to poor management.

Key Takeaway:

While a high occupancy rate signals stability, a temporarily low rate might be a chance to buy into the REIT at a discount, provided that the underlying fundamentals remain strong, and recovery is anticipated.

Investors should avoid REITs with persistent lower-than-average occupancy rates as it is a sign of bad management which is often accompanied by poor distribution and share price performances.

2. Weighted Average Cost of Borrowing

REITs rely heavily on debt financing to acquire and manage properties, making the Weighted Average Cost of Borrowing a critical indicator.

Since REITs operate solely with interest-only loans, any fluctuations in interest rates can have a direct and immediate impact on the REIT’s bottom line.

Why It Matters:

Impact on Distributions: As borrowing costs increase; a greater portion of the REIT’s income is directed towards interest payments. This directly affects the distributable income which inevitably affects the dividend yield of the REIT.
Sensitivity to Rate Changes: In a rising interest rate environment, a REIT with high exposure to floating-rate debt may see a sharp decline in its distributable income. In response to the expected decline in distributable income, the share price of the REIT may suffer from a disproportionate drawdown as investors re-value the REIT and rush for the exit.

In 2022, we witnessed a more recent instance of the iEdge SREIT ETF facing a 24% decline due to the continued increase in interest rates.

While the distributions of the REITs are indeed affected by the higher borrowing cost as we’ve seen in 2023, it is also an open secret that the higher-than-average interest rate environment will not persist and that rate cuts are expected to begin in 2024.

In theory, a temporary increase in the weighted average cost of borrowing should not have much impact on the long-term intrinsic value of the REIT. But in reality, the market is often short-sighted and would behave irrationally which presents long-term investors with opportunities to buy at a discount.

To help you make sense of the plausible impact of a high or low-interest rate environment, you can perform an interest rate sensitivity analysis to estimate the likelihood of distribution changes given a certain change in the weighted average cost of borrowing.

An example of such an analysis is as follows:

Key Takeaway:

Monitoring the weighted average cost of debt is critical for anticipating how interest rate changes could affect the REIT’s ability to pay dividends. Understanding a REIT’s debt structure and its sensitivity to rate fluctuations is key to long-term income stability.

Investors should not be spooked by a sudden increase in the weighted average cost of debt and should instead focus on how persistent the increase would be moving into the future. If the high-interest rate environment is merely temporary, investors should not be too spooked by the sudden decrease in distribution and learn to embrace it as a storm that will soon pass.

3. Growth Plans of the REIT Manager

The growth strategy of the REIT manager is another essential factor to monitor.

In recent years, there has been a growing trend among REIT managers to pursue offshore acquisitions to diversify their property portfolios and capitalize on opportunities in countries with lower borrowing costs.

While international expansion can offer attractive returns, it also introduces additional risks that investors should consider.

Why It Matters:

Foreign Exchange Risk: When a REIT invests in foreign properties, it exposes itself to currency fluctuations, which can affect the value of its income and assets.
Political and Economic Risk: Offshore investments may be subject to different regulations, political environments, and economic conditions, which could introduce another layer of uncertainty.

While these offshore acquisitions can be accretive, investors should evaluate whether the growth strategy aligns with the REIT’s core strengths and expertise.

Another factor that investors should watch out for is if the REIT decides to expand outside of their circle of competence.

For instance, if a REIT that has historically specialized in commercial properties suddenly shifts focus to industrial properties, it could signal that the REIT is stepping outside its comfort zone.

Such moves may be red flags if the acquisitions do not align with the REIT’s historical track record or if the REIT’s management lacks expertise in the new market.

One instance of this is Elite UK REIT, where the management has chosen to diversify beyond their office properties by considering a potential acquisition in the hospitality (service apartment) and industrial (data centres) sectors, areas that fall outside their primary expertise.

While such a move might be successful, it introduces a significant degree of uncertainty to investors which is not ideal – especially for those investing in REIT for their retirement income and capital preservations.

Key Takeaway:

Investors should look at the growth plans of the REIT manager with caution. Acquisitions and expansions offer potential but must align with the REIT’s core competencies. Mismatched acquisitions could increase risk without delivering the expected returns.

Conclusion

Monitoring these three key REIT indicators—occupancy rate, weighted average cost of borrowing, and the growth plans of the REIT manager—can give you valuable insights into the health and future performance of a REIT.

A stable occupancy rate ensures reliable income, while understanding the cost of borrowing helps you gauge how interest rate changes could impact distributions. Additionally, being cautious about offshore expansions can help you avoid unnecessary risks.

By staying vigilant on these indicators, you can make informed investment decisions that safeguard your portfolio’s long-term success in REIT investing.

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