How to Sieve out the Best REITs from the Rest?

Jeremy Chia

Real estate investment trusts, or REITs, with its exposure to real estate and its relatively high and sustainable distribution yield, have certainly been a popular investment choice of late. But with so many REITs in the market, choosing the one that can provide market-beating returns can be a tough ask.

Thankfully, one thing that I believe can give investors a head start is by looking for REITs that have prudent debt management strategies. A REIT that has managed its debt prudently is more likely to be able to have the financial muscle in the future to withstand any economic downturns and to expand its portfolio when the opportunity arises.

With that in mind, here are three aspects of a REIT’s debt management that investors should take note of.

Source of borrowings

REITs use a variety of sources of borrowings. These include bank loans, bonds, revolving credit facilities, and equity fundraising. They can also either borrow money onshore or from offshore sources.

Ideally, a REIT that can utilise multiple sources of debt financing demonstrates its financial flexibility and ease at which it can borrow money for expansion. It also signals that the REIT has the confidence from its creditors that it has the financial muscle to pay off its loans.

Hedging strategies

REITs tend to reduce their interest rate risks by putting hedging strategies in place. Hedging could be achieved through the use of interest rate swaps or the issuance of fixed-rate bonds.

By analysing how much of a REIT’s debt is hedged or on a fixed rate, we can better assess whether an interest rate hike will affect the REITs profitability in the future.

Generally, REITs that have a larger proportion of hedged or fixed-rate debt are less likely to be affected by interest rate hikes in the future.

Debt maturity profile

The debt maturity profile refers to the date when borrowings are due. Investors can find the debt maturity profile in a REIT’s annual report or quarterly presentations.

There are two things that investors need to assess here. One, the longer the debt maturity profile, the better as the REIT does not have to worry about rising interest rates until the debt matures. Two, the REIT’s debt should mature over a staggered period. This reduces the risk that the REIT needs to refinance all of its debt in a period of high-interest rate environment.

The Foolish bottom line

A REIT’s debt profile can tell the investor many things. It gives us a better idea of how prudent and well managed the REIT is. It can also help us identify REITs that have the financial muscle to expand its portfolio through any debt headroom that it has. Hopefully, this article gives REIT investors a clearer idea on how to assess a REIT’s debt and how to sieve out the good investments from the poor ones.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.