Inconsistencies in rental revision computation may give investor an over-optimistic or pessimistic impression of the property situation as well as manager’s ability.
Recently, Prime Grade A focused commercial REIT Keppel REIT (dividend yield 6.3%) made an annoucement regarding the way they compute their rent reversion.
Underlying REITs are different properties that the REIT rent out. These lease terms could range from short of 1 year to as long as 20 year (for some of Keppel REIT’s Australian properties for example). When the term expire, the tenant and the landlord have to negotiate for a new rent for the renewal, and other details such as how long to rent for, incentives, and other terms.
During good times, when there is limited supply and booming demand, the rent reversion can be high positive. During bad times, where there is more supply and demand is low, rent revision likely will be negative.
Rent reversion therefore depends on the demand and supply environment, the quality of the property, managers ability and other factors.
The impact to the investors is that this affect the dividends per unit you will receive going forward, whether for the better or worse. It also affects the intrinsic value of the REIT, since the value of the REIT is the aggregate of the discounted cash flow of the collection of assets.
Keppel REIT’s Surprise
In 2016, the 4 quarterly financial announcement put Keppel REIT’s management in a very good light. It show them navigating very well in a challenging environment where supply is increasing and demand is going down.
They were able to proactively renew leases that were not expiring in the next quarter and maintain occupancy. Having the properties occupied is better than being vacant and Keppel trying to demand unrealistic rent that is far from the market rent. (you can read the 2016 commercial REIT review here)
In the latest announcement, Keppel REIT revealed that, if they factor in some leases that were not reported the 2 quarterly reversion swing from positive to negative 11% and negative 9% respectively:
This announcement reveal inconsistency in the way rent reversion is being reported. By using different methodologies, the rent reversion swings from positive to very negative.
In Keppel REIT’s case, what was not included was the review leases.
Review Leases refers to the tenants on long leases. Typically due to the long leases, the landlord will embed a 3 year, 5 year or half the term rent review. The ones most famous in the news would probably be Toshin legal tussle with Ngee Ann City, Starhill Global REIT.
Keppel REIT’s Singapore portfolio was included excluding 1. Their Australia Portfolio was not.
The very strange thing is, prior to the last 2 quarter (Q1 vs Q2 and Q3), the reporting was totally different.
The following is Keppel REIT’s Q2 reporting:
And the Q3 Reporting (note that review leases were included, but it also included some other non rental compensation and advertising income):
The narrative isn’t very clear on Rent Reversion for Keppel REIT. You wonder if that is deliberate. You can choose what you do not say.
However, it should be noted that the Australian portfolio made up a small amount of Keppel REIT’s net property income.
And in theory, the leases did not expire!
Keppel REIT reports that they will change their methodology back to how they compute in Q1.
The Issue: Rent Reversion is not Standardized Across the Industry
Business Times have a coverage on this issue. Credit to them, they do good work here. What they found was that, there are no standardization, but there are similarities
- The REITs tend not to include new units or reconfigured units, because there were no past history to measure against
- The REIT managers tend to agree if in the property there is only one lease renewal among many leases, it is better to exclude this lease from calculation. The reason seem not that its pro-investor, but it would expose who the tenant is.
- Cambridge Industrial tend to include new tenants that take up space in outgoing tenants. However, Viva Industrial and Ascendas REIT do not do that
- There are a few commercial REITs like CCT and OUE that includes the passing rents of those that expired, and the range that new rents were renewed at (see figure above). This is a very clean presentation in my opinion, however, you do not know how many is in the lower rent versus how many are in the upper range
Business Times did a survey and tabulate as follows:
You basically see the problem here. What is included is one thing, how to compare is another.
1) I find it conservative to use new first year rent versus last payable rent. I think this one reflects the cash flow well. If you are a REIT with rental escalation such as Frasers Logistics and Industrial trust, or Keppel REIT’s 20 year Australia Office that is up for renewal, and their last year payable rent is higher than the market rent (due to the actual economy growing slower than the rent escalation) then this revision will be very telling.
2) Average rent of new period versus average rent of last period seems to me to be not comparing cash flow but comparing the income statement. Some REITs practice straight lining, for properties that have a fixed rental escalation of say 3%/yr over 5 years, such that on their gross rental in the income statement it will show the same value over 5 years (instead of seeing it increasing 3% yearly)
3) But I think what MCT and Cambridge did is the best because they essentially marry the 2 above.
As an investor, what you are very concerned about would be:
- Is there some possibility that the forward dividend per unit will end up lower
- How does the future look?
1 and 3 seem to satisfy this.
What does this mean for the REIT Investor
The biggest impact for investor will be, we do not know which method of rent reversion the manager is using.
We always thought its the same!
Had Keppel REIT not made that announcement and Business Times have not done the good work, novice investor like myself might be framing the prospects of these REITs wrongly.
As an investor, your job is to figure out the forward looking cash flow prospects and the business prospects.
Now that we know it is not so clear cut, it means that you can follow up with investor relations, or ask during AGM meetings questions related to the rental reversion in detail.
The main thing to find out is to have a picture of the forward rental cash flow that is untainted by as much doubts as possible.
Questions would include:
- for this reversion info, what makes up what was computed, are there notables that was not included?
- how is passing rent and rent reversion computed
Lastly, don’t take it that if the rental escalation is 3%, you are going to see the income available for distribution go up 3%/yr. It does not always translate directly.
In many instances, the landlord do give incentives (money or intangible) so that the tenants continue to stay with them. Net net, the growth may even be negated.
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