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Saizen REIT: Deeply undervalued but is it a BUY for you?

Friday, April 3, 2015

Regular readers know that I have been invested in Saizen REIT for a long time. Some might even be able to write a script for a K-drama based on my experience with the REIT. Anyway, if you are interested in the history, just use the search function found in the top right area of this blog. I shan't bore you.

I mentioned Saizen REIT in the last "Evening with AK and friends" session and went on to highlight why it is one of my top 3 investments in REITs. I think that episode might have interested quite a few members of the audience as I received not one, not two but three emails asking me whether the REIT is priced fairly now. I must say that the emails weren't phrased exactly like this but they were close enough.





Taken on my last trip to Japan. Love the chocolates. Cheap too.


I will say that we must question, as always, our motivation for thinking of investing in Saizen REIT. Is it for income or capital gain?

For someone who is thinking of capital gain, the fact that Saizen REIT is trading at a huge discount to valuation might be the reason for his interest. At 86c a unit, it is trading at more than 20% discount to its NAV/unit of about $1.10. This is despite the continual fall in the JPY against the S$. Even at its high of 98c touched almost a year ago, it would still have been undervalued based on the weaker JPY today.

The first question we have to ask, of course, is whether the NAV is realistic. The best way to ascertain this is to see what price Mr. Market is willing to pay for the REIT's properties. In September last year, I said that the REIT sold two properties at premiums of 19% and 12.8% above book value. That told me that the REIT's NAV was conservative. In the REIT's February 2015 presentation, they reported that another property was sold at 16% above valuation.




There is some deep value in Saizen REIT's portfolio of freehold residential properties in Japan, I believe. However, whether the value could be unlocked and returned to unit holders is much harder to say. Could we see an acquisition by a residential J-REIT? I know that a substantial shareholder, Argyle Street Management (ASM) was pressing for something to this effect.

So, anyone who is buying into Saizen REIT, hoping for value to be unlocked, will have to be patient and also remember that it might or might not happen. While waiting, Saizen REIT offers about 6c in DPU per year. Based on 86c a unit, that is a distribution yield of about 7%.

For someone who is thinking of investing in Saizen REIT for income, it is important to bear in mind that income is generated in JPY by the REIT's assets but converted to S$ for distribution. There is always risk in foreign exchange rates. What do I think?


Gingko tree. So many of them in Japan.


The JPY has fallen a lot in the last 2 years against the S$. It is my opinion that any further fall is likely to be mild as:

1. The S$ is also weakening because the M.A.S. is mindful that Singapore must remain competitive and with the dramatic fall in the price of crude oil, Singapore's economy has become mildly deflationary of late.

2. The Japanese government wouldn't want to cause hardship for the Japanese people which any greater fall in the value of the JPY might bring. Already, the people are grappling with much higher inflation in prices of imported goods.


Having said this, for the income investor, what is very important to note is that Saizen REIT's loans are amortising in nature. I have mentioned this many times in the past when I was more active in blogging about the REIT. This means that the principle sums shrink over time as they are paid down. Amongst S-REITs, Saizen REIT is probably the only one that has this feature.




Also, amongst S-REITs, Saizen REIT is probably the only one with very long term loans with many maturing in the 2030s and 2040s. Long term loans actually make sense for REITs because property investments are, logically, long term commitments.

Anyway, the point is that because the loans are amortising in nature, Saizen REIT cannot distribute all its income to unitholders. Some of it goes to amortising the loans. However, because Saizen REIT amassed quite a bit of cash from many of its unit holders who exercised their warrants, they are able to use that money to amortise the loans, distributing income as if the loans were non-amortising. One day, this money will run out. Then what?

Then, everything remaining equal, we might see the DPU reduce by two fifths. So, distribution yield might become 4% then. This is something investors in Saizen REIT at the current price must be aware of and be comfortable with.

I estimated before that it would be many years down the road before it happens but when it does happen, the REIT would be even stronger in its balance sheet as its debt burden would have reduced significantly. I like this very much as it would give the REIT more debt headroom to acquire more properties which would mean a higher DPU. In other words, the REIT would be able to grow without having to raise funds from its unit holders.




There are many things which I cannot foresee happening or not happening. Could Abenomics breathe life into Japan's economy in a sustainable manner? Would demand for housing improve, leading to higher occupancy and asking rents? Would the JPY sink much lower?  These are some questions I do not have definite answers to.

However, there are some things that I do know and those are the things that inform my decision to be invested in Saizen REIT, those are the things that tell me Saizen REIT matches my motivation as an income investor. If there should be an unlocking of value sometime in the next few years, it would be a bonus for me. In the meantime, I am quite happy to be paid regularly.

Related posts:
1. Saizen REIT: Sell the entire portfolio?
2. Saizen REIT: Is the dividend sustainable?
3. Saizen REIT: Why did I buy? Would I buy more?

14 comments:

Capricon said...

AK,
How do derive the drop in DPU by two fifth?

Thanks

AK71 said...

Hi Capricon,

It is either 2/5 or 1/3. It is an estimate. See related post number 2 at the end of the blog post. :)

TG 79 said...

Hi AK,

Thanks for your sharing. I believe that Saizen REIT provides good passive income too but one of my concerns about buying Japan-related stocks is that should natural disasters (e.g. earthquakes) happen in Japan, would such stocks be severely affected? While such incidents may impact prices in the short term, having the assurance that the management had insured the properties against natural disasters would provide investors with a greater peace of mind.

AK71 said...

Hi TG79,

I think that we had a full dressed rehearsal in early 2011. It was named a "Triple Disaster". Could it happen again? Well, I think earthquakes are part of the Japanese experience. They cannot be avoided. So, if we should invest in Saizen REIT, this is something we have to remember.

The REIT does buy insurance to guard against damages caused by earthquakes but they will only apply in the worst case scenario. This is to keep the cost of insurance low. If damages are minor, repairs will be funded by the REIT's reserves.

LOL said...

Hi AK,

Been following your posts on Saizen REIT recently. Thanks for sharing your insights regarding the REIT but would like to ask as Saizen REIT did not pay out dividends in one of the years. Do you think that this will happen again?

AK71 said...

Hi LOL,

They had trouble refinancing because the CMBS market dried up during the GFC. Credit was hard to come by then. CMBS was a type of bond before the GFC which was a popular way to finance purchase of properties by REITs.

They had to resort to very dilutive equity fund raising in order to stay afloat and they nearly defaulted on one of their CMBS. This was for YK Shintoku. It was finally fully repaid in June 2011. See: Saizen REIT: YK Shintoku's CMBS repaid.

With liberal monetary easing now in Japan and the relative ease at which REITs are getting loans in the country, I doubt that there would be a repeat of the CMBS saga. After all, CMBS has also become a thing of the past. ;)

Toma said...

Hello AK,

What do you mean by "principle sums shrink over time as they are paid down"?

Don't all loans shrink as you repay them? Sorry got confused at this.

AK71 said...

Hi Toma,

There are many types of loans. There are also those loans which don't require principle repayment. So, the borrower only pays the interest the loan attracts. :)

Rokawa said...

Hi AK,
Can it be said that rising interest is unlikely to affect saizen due to long term loans?
Unlike sreits which has to refinance constantly.

AK71 said...

Hi Rokawa,

Yes, you are right. Funding real estate investments with relatively short 3 year loans doesn't make sense, really. Strangely, that is the way things are done.

Saizen REIT's loans are relatively long term in nature and are taken from Japanese banks. Apart from the advantage of a natural hedge against forex risk, locking in the low interest rates currently available in Japan is to the REIT's advantage.

Many people remember how Saizen REIT suffered when the CMBS market dried up and credit was hard to come by. The Saizen REIT of today is very different from the Saizen REIT of 2007. :)

Shen said...

Dear AK

Recently, Saizen declared a new distribution reinvestment plan to raise capital. This is meant primarily, according to Saizen, to aid amortization of its loans. To me, this new DRP may benefit the long term investor and generate capital growth for Saizen. I would just like to know your thoughts on this. Do you think the DRP will give better cash flow and make it easier for Saizen to maintain its current DPU? Or perhaps even grow its DPU? I am worried about the dilutional effects of the DRP, and perhaps could this be just another REIT that is trying to "grow" so it's management fees can also grow?

Saizen's price has suffered since the announcement, and I can see its CEO Arnold ip starting to decrease his holdings.
Wonder what your thoughts are on this,

Humble student of income investing

AK71 said...

Hi Shen,

OK, a quick background of the DRIP for readers who are not in the know:

Pursuant to the determination by the Manager that the Distribution Reinvestment Plan will
apply to the distribution of 2.93 cents per Unit in respect of the period from 1 January 2015
to 30 June 2015 (the “2H FY2015 Distribution”), the issue price of the new Units to be
issued under the Distribution Reinvestment Plan in respect of the 2H FY2015 Distribution is
S$0.8115 per Unit (the “Issue Price”).


I replied to another reader, Ted, on the possible dilutive effect for unitholders who opt to receive distribution in cash. This dilutive effect will be seen both in future DPU and NAV/unit, all else remaining equal.

If you are wondering if I would be opting for cash or DRIP, for me, it is almost always cash because I invest in Saizen REIT (and other REITs, for that matter) for income.

Only on one occasion, I opted for DRIP and that was for AIMS AMP Capital Industrial REIT because there was an opportunity for arbitrage. You might want to read this to see what I mean: AIMS AMP Capital Industrial REIT: DRIP.

Anyway, I don't think many, if any, unitholders will take part in Saizen REIT's DRIP as its unit price has fallen to 78c today. Might as well buy from Mr. Market if they want to increase exposure to the REIT. ;)

Thomas Ooi said...

Hi AK,

Current activity with Saizen is that it is doing a reverse takeover with Sime Darby. Anyway to review if it is worthwhile investing into it?

AK71 said...

Hi Thomas,

Can't think of any unless you have access to information available to insiders. ;)

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