by: Tam Ging Wien
All examples and stocks quoted here in this article and on the ProButterflyTM and REITScreenerTM site are for learning purposes; it does NOT constitute financial advice or a Buy/Sell recommendation. Contents are reflective of personal views and readers are responsible for their own investments and are advised to perform their own independent due diligence and take into account their own financial situation. If in any doubt about the investment action you should take, you should consult a professional certified financial advisor.
A Real Estate Investment Trust or REITs for short are a type of professionally managed collective investment scheme with its primary business being the acquiring, owning and financing of income generating real estate. REITs have the benefit of providing investors with a regular income stream and prospects of long term capital appreciation.
For more information on how to analyse and invest in REITs, make sure you check out our related articles on REITs here:
Due to is steady stream of income derived from rentals of its underlying real estate assets, REITs are frequently viewed from a yield perspective.
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To know if a particular REIT is trading at a price that is returning a good yield, investors may compare the REIT's DPU Yield against known risk-free rates to calculate the REIT's yield spread.
The risk-free rate is the annual interest an investor would earn if investing in an asset that is considered absolutely risk-free. Typically, the risk-free rate would be the bond yields of a highly rated bond from a sovereign nation. In the case of Singapore, the 10-Year Singapore Government Securities (SGS) can be used as the reference risk-free rate.
At the time of writing, the 10-year SGS is currently trading at a yield of about 2.50% to 2.75%.
A yield spread is the difference between yields of the REIT under analysis against the risk-free rate. The yield spread will provide a measured gauge of the risk premium when investing in the REIT.
The chart above is the historical Yield Spread (%) chart for Fraser Centrepoint Trust (FCT) against the 10-Year Singapore Government Securities (10-year SGS). The historical stock price for FCT is also plotted on the secondary-axis as an overlay for reference purposes.
Since 2012, the average trailing yield for FCT is 5.97% while the average yield spread is approximately 3.86%.
At the moment, the yield spread for FCT is approximated to be 3.01% which is below the 2-StdDev line indicating that its currently trading at a fairly high price.
FCT closed last week at $2.21 (14-Jun-2018).
For FCT to provide the historical average yield spread of 3.86%, it would need to trade at approximately $1.92. That is a 13.1% potential price correction in order for it to revert to its 7-year mean yield spread.
For FCT to reach a good buy opportunity in our view would be for it to trade at at least 1-StdDev above the mean yield spread. At this rate, it would need to trade at a price of $1.80. That is a 18.6% potential price correction.
The last time that FCT traded as such a high yield spread was in Feb-2016 when it was trading at a range of between $1.80 to $1.88.
Prior to that, FCT traded at a yield spread of close to 4.5% in Jan-2015 when it was trading at a range of between $1.88 to $1.92. During this period, the 10-year SGS was low at around 1.20% to 1.40%.
Therefore, it would not be too far fetched to say that FCT could correct to a price of $1.80 to $1.92 one day should the market demand a much higher yield spread from FCT amidst our current rising interest rate environment.
We will certainly be watching these price levels and taking advantage of a significant price correction to enter FCT.
If you are planning your entries for REITs, make sure you enter at a level that gives you a high margin safety. Using the yield spread is one good method to estimate a good entry price with a comfortable margin of safety.
Will the market present investors with such a bargain? Based on the current FTSE ST REIT Index last close of 785 (14-Jun-2018), a 10% fall would bring the index down to the 700 to 710 range. A 15% fall would entail the index trading at the 660 to 670 range. It doesn't seem impossible in our view especially with the rapidly rising interest rates.
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