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Saizen REIT: Risk free rate and unit price.

Saturday, August 31, 2013

This blog post is a response to a comment from Solidcore. See his comment: here.

I am adding to his comment by saying that although understanding our motivations is important in our investment efforts, we have to remember that, alone, it is not enough for us to make sound decisions, of course.

If we believe the news, a 10 year US Treasury will have a risk free rate of 3.5% eventually. This is, however, unlikely to happen rapidly in the near future. Why? The USA is, at best, emerging from its problems and we see Europe and Japan still doing their own QEs with no sign of stopping.

So, if we are after distribution yields from S-REITs, having lower unit prices, everything else remaining equal, is good for us. This is easy enough to understand. However, at the same time, given the realities and the possibilities of the day, we want to avoid capital loss as well. How do we manage this?


For example, Saizen REIT's DPU, using their forward currency hedge rate as a guide, is likely to provide a DPU of 1.1c per annum. 10 year US Treasury now has a yield of 2.7%, if I remember correctly. It was a percentage point lower not so long ago.

So, it follows that Saizen REIT would have to provide another 1% in distribution yield to make itself an attractive investment for income. It will find this harder to achieve since its DPU will decline in S$ terms due to a weaker JPY. Of course, the REIT could have DPU accretive acquisitions in the next few months which is why analysts are saying if we want to invest in REITs, invest in those with room to grow their income distributions. More accurately, invest in those which could grow their DPUs.

All in all, a back of the envelope calculation tells me that Mr. Market would likely be more enthusiastic about Saizen REIT if it should offer a 7.5% distribution yield with risk free rate rising to 3.5%. With DPU estimated at 1.1c, this gives us a target unit price of 14.7c. Isn't that a shocker?

Well, it doesn't mean that we cannot buy at 17.7c, 16.7c or 15.7c. After all, 14.7c might not see the light of day. 14.7c is a number I concocted, after all. Mr. Market doesn't listen to me, does he? For example, I told myself in an earlier blog post that MIIF, post APTT IPO, would only be worth buying at 14c but see what happened recently? ;p

To add, Saizen REIT's loans are all domestically arranged and with BOJ bent on keeping interest rates low, the REIT's cost of debt will remain relatively low. This is demonstrated by the REIT's recent refinancing activity which has lowered its cost of debt. So, there will be some resilience in the REIT's future income distributions.

Such exercises prepare us for what could be the downside potential of our investments. This is also something we have to be comfortable with. So, if we had bought at 17.7c for the projected 1.1c in annual DPU, how would we feel if unit price were to fall to 14.7c? If we are uncomfortable with the downside potential, then, most probably, we are investing with money we cannot afford to lose.

Related posts:
1. Motivations and methods in investing.
2. Saizen REIT: DPU of 0.63c.

13 comments:

JW said...

By the time if falls from 17.7 cents to 14.7 cents, it might have distributed 3 cents of dividends or more.

So was it wiser to have bought at 17.7 cents or wait 3 years later for 14.7 cents?

AK71 said...

Hi JW,

I like how you ended the second sentence with a question mark. Who knows what Saizen REIT's unit price would be 3 years from now?

I know what Saizen REIT is worth today: 25c per unit.

I know how much income I am likely to receive from it in the next 6 months: 1.1c per unit.

What is Saizen REIT's unit price 3 years later? Your guess is as good as mine. :)

SOLIDCORE said...

Dear AK,

I'm honored to be mentioned in your post! ^_^

I tend to agree with your post, only that I simplified the thinking process in my reply so as to scaffold John's thoughts.

Got a question though. Wonder why you would think that Mr Market prefers 7.5% for Saizen. Is this figure Something arbitrary meant as an example or is it your rule of thumb for a REITs annual dividend yield to be at least at US 10 year treasury + 4%? :)

SOLIDCORE said...

Dear AK,

Btw, I've a paper exercise for you. IF Mr Market does go into a maniac depression (which he does once every decade or so), which REIT will be in your shopping list? It's a pretty personal question though so feel free to give two hoots about my question :)

I've prepared my list of shopping items, as well as thought about my possible line of funding (cash, SRS, CPF, share financing up to 2.75x, etc). However, my wife does feel that I ought to hold it back a little even if the opportunity presents itself and I agree with her as she is always my anchor of logic and sense :)

AK71 said...

Hi Solidcore,

I had an inkling that you did but I didn't know what to blog about over the weekend anyway. So, I used your comment as a catalyst. Kamsiah. ;p

Why 7.5%? I just took the distribution yield Mr. Market seems to find acceptable now +1% for the difference between the current and expected future risk free rates. Just a rough figure. Nothing sacred.

If Mr. Market should go into a manic depression, which REITs would I buy? The ones which give me the most bang for my money! Right now, I don't know which ones would they be. ;p

JW said...

Manic depression? Blue chips will be attractive too!

Question is, how many people usually have the funds to go in Big by then? A manic depression could go in tandem with loss of jobs or income :)

AK71 said...

Hi JW,

You are right to bring that up. We must always have a war chest ready.

Blue Chips or REITs, if their prices offer good value for money, I am a buyer. ;)

ryan said...

Hi AK,

May I know how do you derive dividend of 1.1c per unit from? Care to share with us your calculations? Some analyst (http://www.nracapital.com/research/sgxresearchreport/1308QPQN0T) arrives at 1.3c per unit as next year, we will have full year contribution from all properties that were acquired in Q3 - Q4 2013.

Thanks!

AK71 said...

Hi ryan,

I annualised 0.63c to get 1.26c and given the forward hedge rate published by the manager, I discounted 14% to get 1.0836c. I rounded it up to 1.1c. Back of the envelope calculation. ;)

NRA is probably more meticulous and I hope they are right. :D

ryan said...

Hi AK,


Icic. Thanks for your clarification! It seems to me that your logic makes more sense. Now I can only hope that the management would make more yield accretive acquisition next year to make up for the fall in the dividend in SGD.

AK71 said...

Hi ryan,

Well, I like to think that my estimate is realistic. Anyway, given the weaker sentiment towards REITs these days, I won't be surprised if we see lower prices. Not complaining though. ;)

Daniel Chong said...

Hi AK,

Just curious.Given the forward hedge rate for six month ending 31 Dec 13 at JPY81.15/SGD and the previous half year ending Jun 13, the hedge rate is JPY75.12/SGD

When i take the numbers, the difference is ~8% (81.15/75.12). How did you derived to 14%? Do not get me wrong as i do not doubt your numbers, just want to understand how did the 14% was derived.

Thanks

DC

AK71 said...

Hi DC,

Please doubt my numbers! I have been known to make mistakes on my calculator before.

You are right! 8% it is! Yeah! I am happy to be told that I made a mistake in my calculations. ;p

Thank you. :)

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