[Case Study] Why I Sold Off My Keppel REIT Shares

Updated: Oct 17

Keppel REIT is my first ever REIT investment and it is also the first ever analytical mistake that I’ve made as I embarked on my journey in 2023 to start an income portfolio for my financial independence.

In this article, I will share with you what went wrong in my analysis (huge thanks to Vince from reit-tirement for highlighting it to me) and why I’ve decided to liquidate my position and re-deploy my capital into other REITs after holding it for less than 2 years.

Why I bought Keppel REIT

Keppel REIT first came onto my radar largely due to the significant drawdown that was experienced between 2022 and 2023 with the share price experiencing more than 30% drop in a short span of 6 months.

Being a value investor by trade, such a tremendous draw down in short periods always excites me as it presents a possible opportunity to grab valuable companies at undervalued prices – provided that the fundamentals are still strong.

On the topic of fundamentals, Keppel REIT checked all the boxes that I was looking for as an income investor:

High portfolio allocation in Singapore properties – thereby mitigating the impact of foreign exchange rate risk
The portfolio comprises mainly high-grade (Class A) offices which include iconic buildings such as Ocean Financial Centre, MBFC and One Raffles Quay – thereby providing stability in top-line rental income.
Stable dividend distribution behaviour over a long period – thereby providing investors with confidence in the stability of their dividend/income returns

All of these factors reinforced my belief in the stability and resilience of Keppel REIT’s fundamental performances – which to date I still stand by my analysis of the quality of their portfolio and performances.

Given that the dividend distribution of Keppel REIT remained relatively unchanged over the years, the 30% drawdown between 2022 and 2023 appeared to me as a good chance to start a position in a resilient Singapore Office REIT as the REIT was trading at 6.5% dividend yield – which far surpassed my dividend requirement of 5% to 5.5%.

And boy did I start a position. I invested in Keppel REIT at 88 cents per share in May 2023 and averaged down at 80 cents per share in October 2023. At around this time, I recall doing an update on Keppel REIT which is when I was highlighted on my analytical mistake.

Where did I go wrong?

On the surface, my decision to invest in Keppel REIT would have appeared to be a good strategic move and I bet most of you reading would also agree. But upon closer inspection of the breakdown of their distribution, this is where I realise that I may have made a grave mistake in my valuation approach which could have cost me dearly if the markets were truly efficient.

If we were to look at the DPU breakdown (you’ll have to do this manually), one would realise that the only reason why Keppel REIT was able to maintain its dividend distribution over the last two years is largely due to the contribution from non-operational items.

Furthermore, Keppel REIT has a long history of paying their management fees in units which has further inflated the reported distribution figure which is not an accurate representation of the yield from their underlying operations.

Currently, the market and previous I was valuing Keppel REIT on the reported dividends which is why it appeared to be severely undervalued. If we were to expect a 5% to 5.5% dividend yield, the theoretical intrinsic value should be around $1.12 to 1.02, assuming a 0% growth rate in the distributable income.

However, if we were to only focus on the distribution from operations, a vastly different intrinsic value would be reflected:

If we were to apply the same consideration – 0% growth rate in distributable income – we would come to realise that the theoretical intrinsic value of Keppel REIT, based on their distribution from operation, is around $0.62 to $0.68. Which is nowhere near the current price that the market is trading at as most of the market values Keppel REIT based on the reported distribution.

Does it matter?

Given that the market is valuing REITs based on reported distribution rather than distribution from operation, one would question whether investors should care whether the dividend is impacted by non-operational items.

Here are my thoughts on this topic, in the short run, I feel that the emphasis on operating yield is less important as compared to the reported yield so long as you can liquidate your position at a higher price. (This is achievable by trading on narratives without much focus on fundamentals)

However, this is only possible if:

The market continues to disregard the impact of non-operational items and value REITs based on the reported distribution
The REIT continues to pay their management fees in the form of units to continue the illusion of an inflated reported distribution yield.

If you’re a long-term investor, perhaps you should pay more attention to such items as the odds are against your favour if you continue to value REITs based on the reported figures.

We’ve seen a few examples of REIT managers unwinding their decision to pay themselves in units at times when the share price is depressed. This has resulted in further downward pressure on the share price as the market is now forced to value the REIT based on their operation results which will not be pretty.

Some notable examples are Lippo Malls Indonesia Retail Trust, United Hampshire US REIT, Cromwell European REIT, Elite Commercial REIT, IREIT Global, Keppel Pacific Oak US REIT and Prime US REIT.

Even if the management continues to pay their management fees in units, such an action will inevitably result in longer duration dilution that is detrimental to existing unitholders if you are thinking of holding the REIT for the long term.

Eventually, I liquidated part of my positions at 89cents in August 2024 and the entirety of my position in Sept 2024 at 97cents – which represented an IRR of around 15% - and redirected the funds into another blue-chip REIT that was badly beaten down and trading at around 6% yield from operations.

Who knows, maybe Keppel may recover back to $1.10, and I may have lost out on another 20% to 30% of total returns but if that is the cost of investing more safely and focusing on REITs with higher operating yield, I will gladly give up the possibility of earning such returns.

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