One of the privileged presentation during our reader’s sharing Building Cash Flow with Stocks was an explanation of how REITs grow by B from Forever Financial Freedom.
He illustrated based on his competency how the capital management of REITs could take place to grow with debt and equity. I do agree with his thoughts, and my article on how REITs grow have articulate that view.
In this week’s announcement, we see Keppel DC REIT (dividend yield 5.5%), a diversified data centre specialty REIT showing some evidence of this.
Keppel DC bought the “shell and core building” of a data centre in UK for 34 million pounds. The data centre is in Cardiff, Wales and is on a 15 year triple net lease with rental escalations. The client will bear all operating expenses and capital expenditure of the data centre.
This is Keppel DC’s 4th acquisition since IPO in 2014. The acquisition is funded by debt in pounds and will take their aggregate leverage up from 29% to 32%.
Taking advantage of investor’s interest participation to grow
Compare to many high yield REITs, the share price of Keppel DC does appreciate.
The attraction for investors is not based on only the dividend yield. If you buy something at a prevailing 5-6% dividend yield, it does not look as appealing to other High Yield Dividend Stocks on my Tracker.
However, if you look at the total return, which is a 5.5% yield + a 2.5%-3% annual escalation, your total return could be 8%-8.5%. And you have a stability of 9 years.
This permutation attracts, institutional capital and also retail investors.
But Keppel DC REIT, at this point has a gearing of 29%.
According to B and My model, the REIT should
- typically raise debt
- buy appreciating assets
- increase debt head room, so that they can leverage more
- if debt headroom small, use more equity rights issue or placements
Keppel DC still have ample of debt headroom so they could tap it first. And because there is good demand for data centres, the re-valuation also increases the asset value presenting more headroom for debt funded acquisition.
Keppel DC’s share price have been performing well, and since dividend yield is equal to dividends per unit / share price, an increasing share price compresses the dividend yield.
If Keppel DC is thinking of funding a new acquisition purchase with rights issue, or placement, it is easier.
This is because the current cap rate (last net rental income of data centre / cost of data centre at purchase) of the data centers on the market is around 8%.
Factor in a possible 10% management fee from net property income, most purchases are accretive (a boost to your future dividends per unit).
This is one REIT that I am always considering, it has a lot of thing going for it:
- ample debt head room
- good total return visibility
- diversified away from Singapore
- a big spread between current REIT dividend yield and prospective assets NPI yields
- popular among-st institutional investor and retail investor
Hope this is a good case study for you. Let me know your thoughts and caveats.
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Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.
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Pierre
Sunday 9th of October 2016
Keppel DC has some builds with ridiculously short land lease for such a young REIT (for ex their Singapore properties lease expire in 2021 and 2025). Having buildings that depreciate this fast is pretty negative for growth.
Kyith
Sunday 9th of October 2016
good observation Pierre,i am sorry i didnt mentioned it. but i thought its slightly longer than that. its too short.
Bruce
Sunday 9th of October 2016
It is likely this deal was secured prior to the recent depreciation; if assuming it gives the same level of existing payout ratio, 5.5% quoted from your blog, a one-day drop of 6.1% by pound's value wipes out entirely the economic benefits of the Keppel's new investment. do hope it is hedged, or just consider it is Keppel's wrong timing.
ThumbTack Investor
Sunday 9th of October 2016
True... But then again, that's true for all companies, not just REITs. The company's overseas adventure can have ROI of 5.5% and it'd be wiped out easily by the pound's devaluation. UK is something of a unique situation though, as the pound is crazily volatile of late. It would probably get more volatile as negotiations for Brexit commence. Although, I think most companies adopt much longer term views in their investments and projections. (>5 years) At this stage, I don't think anyone knows where the pound is going to settle at in the long run, so any company/REIT with exposure to pound earnings really doesn't know what these earnings are going to be like when converted to their reporting currency. @Kyith: Thanks! I didn't know REITs also hedge Fx. Like I said, I'm not familiar with REITs, never owned a REIT before.
Bruce
Saturday 8th of October 2016
How is that acquisition being affected by UK currency's recent depreciation?
Kyith
Saturday 8th of October 2016
When we have reits that have income from overseas, their takings, after conversion will definitely be affected unless hedge. even then , there is a limit to hedging. so in short, yes it will be affected if its a prolong and consistent downturn.