How To Value REITs Using Dividend Yield Comparison
Updated: Nov 27, 2020
Not all REITs have fifty industrial properties or thirty retail malls. But they make money through collecting rental income from managing the assets. As unit holders, we receive the rental income in the form of dividends after taking into account all the fees and expenses. All REITs are required to payout at least 90% of the distributable income based on the regulation. Thus, when it comes to REITs valuation, that's where the dividend yield comes in.
As the name implies, it's based on dividends and share price. As a reminder, that's how much money an investor receives relative to the share price. In general, you would want to receive as much as dividends possible, allowing you to retire and live on the dividends income one day.
How to value REITs using dividend yield
The dividend yield is a very commonly used metric that's worth wrapping your head around. Plus, unlike any other valuation models, it's rather simple to calculate. Simply take the company's dividend per share and divides it by the share price. Or, you can just go to our REITs data page to retrieve the info.
Source: REITs data
As with any other financial ratios, the dividend yield is mostly not as useful by itself. Of course, one can use it as a guide on how much passive income you are looking for. For example, one might prefer a REIT or stock with at least 5% dividend yield, while another is comfortable with a 3% dividend yield.
A better approach is to compare the dividend yield to its peers (for example, we compared Capitaland Mall REIT with other retail REITs like SPH REIT or Stahill Global REIT).
Source: REITs data
Another way is to compare the current yield with its historical trend. This will give us an idea of whether the current pricing is "expensive" or "cheap". In other words, dividend yield can also be used to establish a fair share price. Take Suntec REIT for example, the historical average yield was 5.92%, with the highest and lowest yield of 8.96% and 4.65% respectively. Using the dividend yield formula in reverse, the FY2019 annualised distribution per unit is $0.1, the fair value of Suntec REIT will be $1.69 ($0.1/5.92%), with a volatility range of $1.11 ($0.1/8.96%) to $2.15 ($0.1/4.65%).
Source: REITs Insiders
With the latest share price of $1.83, Suntec REIT is slightly overvalued based on dividend yield. This approach is often used in private equity funds for their yield portfolios. Our insider portfolio uses this dividend yield valuation method as the key components in our REITs selection.
But be wary when comparing historical average dividend yield to value a REIT. For example, Lippo Mall is currently trading at a 9.5% annualised yield, which is higher than its historical average of 8.6%. One may think that this could be a good deal. But if we look at the share price and DPU in more details, we will notice that both the share price and DPU were in the downtrend in the past five years.
Source: Lippo Mall's yield trend from REITs Insiders
This is actually a warning sign on the REIT's fundamentals. The current yield is higher as compared to its historical average, which is mainly due to the drop in share price (more than 50% drop), rather than the improving fundamentals or portfolio enhancement. Besides the dividend yield, you should, therefore, look at DPU over the years as well. A good REIT with a solid portfolio and competent management should payout higher dividends over the years (e.g. Mapletree Commercial Trust).
Source: Mapletree Commercial Trust's rising DPU and share price from REITs Insiders
Summary
Dividend yield valuation method lies in their being able to formalise those assumptions and apply them somewhat consistently across the REITs. But you still have to find a way to understand a REIT, financial metrics that can give you good numbers.