Friday, January 30, 2015

Buying REITs with NAV Premium?

Above is the chart of Cambridge Industrial Trust. I went back to trawl through their press releases and I graphed the NAV from the day after the results are released until the next results are released. I did not take the date last reported because it is not useful. We will only know this updated information the date after the announcement, which is why I used that date.

Interestingly, just recently back in May 2014, this REIT was trading at 12.95% premium over it's NAV! Currently it is trading at NAV.

After reading the REIT Bible and many other resources, I believe that the price paid in relationship to the NAV is the most important metric for a REIT. Obviously P/NAV should not be used as a standalone metric. The world of fundamental analysis has given us countless of metrics to use, why limit yourself to just one?

However, P/NAV is my go-to metric when I look at REITs. Different segments of REITs have different "natural" premiums or discounts to their NAV. For all segments, the natural standard deviation is 5%. This means that that the P/NAV generally tends to range between -10% of the natural premium to +10% of it. In the case of Industrial REITs, the natural premium is actually 5% and we should expect to see P/NAV ranges from -5% to +15% typically.

Of course, individual REITs have their own unique characteristics and attributes, so within a segment it is normal to see certain REITs always commanding a higher premium than others. This can be caused by a variety of factors such as asset quality, management, sponsor, location, etc. Even the method of accounting and valuation is important, as discounts or conservative estimates have to be applied to the reported values.

Healthcare REITs have a natural premium of 20%. Looking at S-REIT System Investor's post regarding First REIT, you can see that his very nice graph of First REIT's premium over NAV seems to confirm that the typical range of a healthcare REIT should fall between 10% and 30%.

I believe what happened in the 1st half of 2013 was an anomaly. Many REITs went ballastic at that point of time. Parkway Life REIT (healthcare) went up to 81% premium over NAV, while Ascendas REIT (industrial) went up to 50% premium over NAV. Disasters waiting to happen. And that's what happened. 2 months later, Parkway Life REIT shed 20% while Ascendas REIT shed 40%.

My point is, unless you can justify strongly why a certain REIT deserves to command a premium over it's NAV, it is probably a safer bet to buy REITs below their NAV.

Anyway, as mentioned earlier, in the case of Industrial REITs, the natural premium is actually 5% and we should expect to see P/NAV ranges from -5% to +15% typically. This means that Cambridge Industrial REIT is actually at the lower end of it's typical range. Does this mean that it is a good time to buy it?

By that logic, Sabana REIT is extremely attractive (-12%) and AIMS AMP Capital REIT is e also attractive (-4.2%). However, P/NAV is not an exact science. Like I mentioned before, a variety of factors come into play that eventually gives each individual REIT a premium or discount to NAV.

Perhaps in these cases they are warranted. I personally feel that Industrial REITs are going to be facing a lot of issues that affect the simple supply and demand in their segment.

However, in other cases, I think the market is massively mispricing them. Lippo Malls (retail) is trading at a 17% discount to NAV while Saizen REIT is trading at 35% discount to NAV.

I have previously shown that the mispricing in Saizen REIT is insane, especially if you are a Japanese investor and have other Japanese residential REITs to compare Saizen REIT to. Since my post, yields of J-REITs have dropped another 60bps while Saizen REIT has actually not moved at all. If Saizen REIT was listed in Japan and reached roughly the average level of P/NAV and dividend yield of other residential J-REITs, it would appreciate 100% in value. Of course, with Japan engaging in the coordinated systematic suicide of their economic while also blowing up their currency in tandem, I admit that there are risks investing in Japan.

The other line of thought is to not look at residential J-REITs as a standalone niche segment in this asset class, but to look at them as part of the entire REIT landscape available to local investors. In that sense, it means that investors believe that only at a 7.1% yield is Saizen REIT an attractive buy, regardless of P/NAV. There is no fault in that logic either.

Personally, I am willing to take sit on these 2 counters that investors perceive to be on the risky end. I already have. I actually feel that their mispricing ironically makes them safer investments. Saizen REIT and Lippo Malls are the 2 biggest holdings in my portfolio.

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