One sign of a Real Estate Investment Trust (REIT) market reaching maturity is the ability of existing REITs in raising significant capital for new acquisitions. Using this metric, the recent deal completed by Mapletree Commercial Trust – where it raised $1 billion for acquisitions – certainly adds to the track record of the Singapore bourse.
While REITs are considered to be a type of commercial real-estate asset class, a crucial difference between REITs and other forms of real estate investments is the former’s ability to modify its portfolio. The management team is entrusted with the power to acquire new assets, renovate or redevelop existing assets, or to sell assets. If executed correctly, these various strategies allow a REIT to maintain and improve the quality of its assets and to seek alpha via intelligent asset trading.
Traditionally, the first phase of a REIT market’s expansion includes the acquisition of assets. For regular investors, this is typically the first opportunity to gain exposure over the country’s iconic assets, such as landmark office buildings and major malls.
As the REIT market matures, new management teams will typically seek new niches, expanding the type of assets that are owned by REITs. Industrial buildings, hotels, logistics centers, and data centers are all examples of assets that have served well as REIT asset classes. Secular changes in the economy, such as the development of the Internet Economy, may also prompt REITs to shift their focus and acquire new types of assets. In general, the REIT sector as a whole ought to grow with the changing needs of the society.
Renovation and redevelopment are the second set of strategies employed by REITs. Because real estate is a physical asset, regular renovations are essential as physical assets are subjected to wear and tear. For some asset types, retail in particular, renovation is scheduled to maintain a fresh profile. Major malls are typically renovated every five or seven years with new themes and décor, so that customers are interested to patronise regularly.
Most REIT markets with a longer history have regular redevelopment work, which are usually undertaken for three different reasons:
1. The existing asset might not have exhausted all the available floor area of the land. In some cases, the developer may choose to develop a smaller building than is legally permitted and wait for demand to build up. The landlord may also subsequently acquire land adjacent to an existing asset to increase the available floor area. Sometimes, changes to a country’s or a city’s planning codes may also increase the available floor area. In any case, redevelopment may make sense for a landlord if it simply allows the landlord to increase the building size.
2. Design requirements and preferences may change through time. For example, office buildings built in the 1970s and 1980s typically have lower ceiling height than buildings built after that period. One reason was that modern offices need cable space to connect work computers. The common solution in the newest office towers is to raise each individual floor to create that space. Thus, the overall floor height needs to be increased to accommodate this new requirement, and typically, the only way to substantially increase building height is to redevelop the asset.
3. Optimal building usage may change over time. Many hotels, for example, may have been built near the edge of the central business district. But as the central business district expands, the hotels may now be occupying land that would fetch a much higher rent and, thus, increase in capital value if it were to be redeveloped into an office building. Many industrial districts, similarly, have been converted into residential or retail districts as cities expand into suburban areas.
Selling assets is also a way to improve a REIT’s overall health. Some assets may become old with little redevelopment potential, for example. Selling these assets would improve the average quality of the REIT. At times, often around market peak, other investors may also bid for assets above their long term value, making it worthwhile for a REIT to sell the assets. Alternatively, a REIT that intends to refocus its portfolio will also need to sell its other assets in a thoughtful way. The proceeds from an asset sale may be used to pay down debt, to recycle into other projects, or to pay dividend or buyback shares.
Over the medium term, a REIT’s trading price typically correlates with its per share Net Asset Value (NAV). If executed correctly, all three strategies mentioned above can increase a REIT’s per share NAV. This is why – as analysts and investors – one of our key tasks is to identify capable management teams and potentially successful asset strategies that may consistently improve the per share NAV.