You must learn to avoid investing in sub-par REITS. These have:
1. overly high level of debt, and
2. inconsistent or declining income for distribution.
Here are 6 screens for finding the best REITs:
1. High distribution yield (at least 5%)
A low distribution yield (less than 5%) tells you that the REIT is currently too expensive to buy.
2. History of consistent growth in DPU.
You need to ensure that the REIT you invest in has a history (at least 4 - 5 years) of consistent increase in their distribution per unit (DPU) (i.e dividend per share).
3. High expected DPU growth in the next 1 - 2 years
You have to ensure that the REIT you buy is expected to generate increased income and distribution in the next 1 - 2 years. This comes from expected increase in property prices, increase in rental or acquisition of new properties.
Cyclical REITs like office, industrial and residential REITs should not be bought when the economy is entering a recessionary phase. This is a time when these property prices and rental income are expected to decline. They should only be bought when the economy is recovering from a recession or in an expansionary phase.
4. Low gearing ratio (< 40% )
Since REITs must pay out 90% of their income in dividends, most REITs can only acquire new properties by taking bank loans. When a REIT takes on too much debt, it exposes itself to interest rate risk and even defaut risk (when it is unable to service the repayments).
5. REIT stock price is fairly valued
As an investor, you would want to buy a REIT at a time when its price is below its NAV (undervalued). Such opportunities arise when there is a lot of pessimism in the market. At the same time, when the price has risen too high above its NAV (overvalued), you may want to avoid buying the REIT.
6. REIT must be on a confirming uptrend.
DPU = Distribution per unit.
Ref: Adam Khoo
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