What to take note of when investing in REITs - Part 2

This is a continuation of sharing what to look out for when investing in REIT from my previous article which you can access here.

Readers of my blog will know that I am generally fond of REITs for their distribution payouts and preference for an income investing strategy, making them a popular component (and in some cases, predominantly so) of one's portfolio.

Previously I have discussed about the Property Sector, Gearing and Financing. In this article, I will talk about Weight Average Lease Expiry and Management.

Weighted Average Lease Expiry (WALE)
One of the key risk REITs face is vacancy of their properties. When properties remains vacant for too long, income and hence distribution gets cut as well. This is where WALE comes in as a metric to evaluate the REIT.

WALE is measured across all tenants’ remaining lease in years and is weighted with either:

• The tenant’s occupied area against the total combined area or;
• The tenant’s income or against the total income of the other tenants

For the purpose of this article - longer WALE will refer to those with  5+ years, while shorter WALE will be those of < 4 years.

Properties with long WALE face less risk of vacancy and major tenants (anchor tenants) in properties can greatly affect the WALE so they tend to get the best rental rates.. Take for example properties with WALE of 5 years - they usually have been commitment of leases from large organisation such as MNCs and hence offers stability in income and has an inherently defensive nature. This stability comes at the cost of opportunities to negotiate rent hikes in comparison to smaller tenants however.

In spite of the consensus that longer WALE = better, shorter WALE may not be all bad. Properties with shorter WALE usually has smaller businesses, which usually does not commit to longer lease term in comparison to the larger businesses such as MNCs. Although there is higher vacancy risk and possibly processing/advertising fees involved in properties with shorter WALE, this offers opportunities for rent hikes and hence avenue for growth in income.

Even among properties with shorter WALE, however, there may be scenarios where WALE is questionably short. Properties with WALE which is too short may be a concern to investors - see my post regarding the planned acquisition of properties by Cromwell European REIT here. Some of the properties to be acquired has WALE of < 1 year.

Management
Management most definitely plays a vital role in the REIT in that the quality of decisions they make can either create or erode value, such as:

• What value are they acquiring new properties or divesting existing properties, its benefit or reason, and whether that aligns to the management's vision.
• What strategy does the management have to drive growth in its portfolio / distributable income. For example, Fraser Logistic and Industrial Trust intends to achieve organic growth through increase in properties rental and inorganic growth through expanding its portfolio.
• In a softer market, what strategy does the management have to ensure resilience in the REIT's performance. For example, Cache Logistic Trust has divested Jinshan Chemical Warehouse as part of their portfolio rebalancing strategy (which has been ongoing since the acquisition of Australian properties).
• How is the management fee in comparison to the other REITs. It's also desirable to find REITs which has the management fee tied to how well it has performed as compared to a fixed management fee.

While the saying "past records are not indicative of future performances" will always need to be kept in mind, they do offer an area which one can evaluate the quality of management.

Thanks for reading!