Saizen REIT: Risk free rate and unit price.

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.