Tuesday, September 23, 2014

P/NAV REIT Analysis: Case study of CapitaMalls Trust

I have long wanted to do this, so here it goes.

After reading the "REIT Bible" by Ralph L. Block (Chapter 6) and also some simple slides from Green Street (see page 11 of the 2014 pdf file), I think that one of the most, if not, the most important thing about REIT investing is not to pay a significant premium over NAV.


Although I think P/NAV is probably the most important metric to use, it would of course be foolish to limit yourself to just one metric. Other metrics ought to come into play, to help you decide whether the P/NAV premium or discount observed is warranted or if there is a mispricing. Looking around at the other things under the hood, you may find that there are reasons why such REITs are constantly selling at a premium or discount, and then you can adjust your P/NAV expectations accordingly.

For example, from the Green Street picture above, you can see that healthcare REITs are always constantly trading with a premium to their NAV, about 20%, and they will fluctuate between 0% - 40% premium based on a variety of factors, such as asset quality, management, locations, etc. Currently, ParkwayLife REIT trades at 44% over premium while First REIT trades at 27% over premium. Are these crazy premiums for REITs? My personal opinion is no because they are healthcare REITs and actually quite nicely fall within the range of likely premiums, albeit with ParkwayLife at the tail end of the high side. However, a historical P/NAV analysis of these REITs might show you a time period where these REITs are trading at the lower range of their P/NAV ratio. Although this might still be a premium over regular NAV, this might actually be a bargain considering their warranted premium! So, I will attempt to look at CapitaMalls Trust using historical P/NAV.

(OT: Many investors say that rising interest rates are bad for REITs because interest rate expenses will increase and higher bond yields will also make REITs relatively more unattractive. AK have written an excellent piece on how rising interest rates would affect REITS. I agree that interest rates will affect the REITs for sure, but I think that interest rates is only 1 piece of the puzzle and the supply and demand of the real estate plays a larger part in determining the success of a REIT. Gearing, Cost of Debt and % of fixed Debt are still great metrics to consider, but should not be looked at without looking at other aspects of the REIT as well. I personally like to view REITs as a unique asset class which is affected by a different set of risks that is different from common stocks and bonds)

CapitaMalls Trust is the highest credit rated REIT on the SGX with a rating of A2 from Moody. I have written about REITs credit rating before, and so has B from A Path to Forever Financial Freedom.

Anyway, I have spent some time this weekend to finally get down to extract some data. In all honesty, I question how accurate the "price" data is, because I could only find monthly values from Reuters for the time periods really far back. Oh well, here it is anyway.



The easiest line to explain is the Orange Line, that is the historical quarterly price of the stock. Not much explanation needed I feel. That is the line we all see.

The Red line is probably a bit more interesting, and that is the underlying NAV of the stock.

The Blue line is the line that I find the most interesting, and that is the P/NAV ratio.

I think the nicest thing to look at is the pretty stable NAV movement of the stock. As you can see from the Red line, the NAV of the properties held by the stock does not fluctuate much. It did suffer a big decline during the GFC, but it has been steadily climbing, from 1.52 to 1.78 as of last quarter.

The Orange Line is a big more crazy and erratic, but that is what stock prices are like. The main point that I would like to highlight is that the stock price bounces around its NAV, the Red line.

This erratic movement of bouncing above and below the NAV is the premium and discounts that people are willing to pay, which is the P/NAV ratio, or the Blue line. Looking at the historical P/NAV, we can see what is the usual range that the stock trades in, as well as the width of the range as well, which will tell us how volatile pricing may be, which helps us look for ratio extremes.

Personal Observation: Other than the GFC period, CapitaMalls has been constantly trading over their NAV, which I think is quite warranted given that they are really the biggest and strongest brand name REIT that everyone starts out familiar with. With it's current P/NAV near the lows of its normal ratio range (1 - 1.3), excluding crisis period, I think that this might be a decent period to accumulate the best credit rating REIT available for the long term investor. Unless a crisis occurs, which would likely affect the entire industry as well, CapitaMalls actually looks attractive now although it is trading with a premium to it's NAV.

I'm not saying that this is the best way to evaluate REITs. This is just my personal train of thought if I was doing a P/NAV analysis. There are still plenty of other things to look at and consider. Many people look at dividend yield, gearing, P/FFO or P/AFFO which are all excellent metrics that give you insightful information about the REIT. However, my personal preference of a starting point when looking at a REIT is the P/NAV ratio.

I often wonder how others analyze REITs and come up with the final conclusion of choosing one stock over another. What are the metrics that you use to evaluate REITs? I would love to hear some of the things that others look out for!

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