REITS Valuation – Jayaraman

Now this is the earlier (2012) version of the book. There are some underlying similarities between Mark Lin and Jayaraman’s approaches. This much is clear – they remind readers to be conservative, that is to be careful. (As far as I understand, Li Ka-Shing advises likewise. On a related note, Buffett himself prefers stocks that are non-volatile. Indeed, steady does it.) For formulas and calculations though, I have yet to find many common ones, save perhaps for the factor of ‘risk free rate’.

In Chapter 6, Jayaraman initially identifies the ‘yields based’ (dividend) and Net Asset Value (NAV) methods. Then he refers to a few others.

Yields

Investors may buy REIT units at yields lower than risk-free rate (10 year Singapore Government Bonds) due to expected growth (via higher rental intake and property values). *

A REIT deemed risky would have to offer greater yields to attract shareholders. But higher yields may also be a result of loss aversion during downturns or recessions. Yields started from 10% at the beginning of 2009 (global subprime crisis).

From the book exposition, ‘market price’ is the same as ‘trading yield’.

NAV

Investors are apprised every 3 months of the NAV (assets – liabilities) in financial statements. (The Monetary Authority of Singapore mandated at minimum, annual NAV reports). But generally, Jayaraman sees this as insufficient on its own.

DCF (Discounted Cashflow)

This requires predicting rental income for the next 5 or 10 years; and the sale price (terminal value) of the property at the 5 or 10 year point. This is often done by ‘capitalising the NPI’ (Net Property Income) in the 5th/10th year. So the cap rate (capitalisation rate – stable first year net operating income divided property capital cost) value is critical in the equation. Both the predicted income and property values are combined and then discounted ‘back to present value or today’s dollar using a rate of return required by investors’ for similar property types.

Replacement Cost (RC) 

Basically: how much does one have to pay for a comparable property. To arrive at this, it entails information on:

  • recent land bid prices
  • construction costs
  • interest expense
  • marketing payments etc.

From this cost of a comparable building in the area, one deducts building depreciation (and land depreciation in case of a leasehold). Where ‘transaction costs’ exceed RC considerably, there may be eventual building oversupply since it had been more affordable to construct than to purchase/acquire existing properties.

Jayaraman cautions us that local land bidding is ‘mainly sentiment’ based, and from his experience it can fluctuate greatly in the span of 12 months.

Notes:

10 year Singapore Government Bonds were sold/purchased at around 2% yields in 2012, according to Jayaraman.

 

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