Using debt to generate income.

I went for an evening walk earlier and during that one hour, I thought about many things. Well, that isn't unusual for me. I think too much, many tell me. One of the things I thought about was the issue of debt used in investments.

For example, how risky is an investment for which the debt is meant to fund? People always wonder how to measure risk properly and there are people who are paid to study and manage risks. I am not a professional in this area and I only have a very simple understanding of the matter.

One consideration which is probably universal is that of time. Time? Yup, time.

Basically, the longer a business investment makes me wait before I am rewarded, the riskier it is. The prospective returns will have to be much higher to compensate for this risk. So, if debt is used to fund an investment with a long gestation period, I would consider it risky and would require a much higher return to be interested.

If an investment would generate income very soon, then, the use of debt in such an instance could be considered to be less risky. In such an instance, I might be quite happy with a lower return on investment.

Another example of a question to ask is whether the benefits generated from the investment are sustainable. If the benefits generated from the investment are sustainable, then, the use of debt to magnify the benefits would make more sense.

Debt can be good or bad. It is too easy to say that we should avoid highly leveraged investments but we really should examine each leveraged entity closely and not generalise.

Related posts:
1. Don't think and grow rich.
2. Secret to avoiding financial ruin.
3. Get on top of your finances.
4. Snowballing towards bankruptcy.
5. Total Debt Servicing Ratio (TDSR).

Saizen REIT: A foreign talent!

This blog post is written in reply to a comment by a reader with regards to Saizen REIT. Read the reader's comment: here.

My reply:

Hi Simple Boy,

The way in which you annualised the income distribution is valid. It is always an estimate anyway and discussing whether it is accurate or not won't be very meaningful, I feel. So, I shan't be crunching numbers here.

As for comparing Saizen REIT's distribution yield against those of other S-REITs', I think it could be doing Saizen REIT an injustice to do so.

Firstly, different property types will command different yields and certain property types command higher yields. Saizen REIT owns residential real estate which, usually, are lower yielding. However, the demand for rental properties is relatively inelastic, especially in a country like Japan where the majority rent their homes. We don't have another REIT in Singapore that holds residential real estate for us to do a comparison against Saizen REIT.

Secondly, in the world of S-REITs, Saizen REIT is a rather strange animal because it doesn't have any properties in Singapore. All of its properties are in Japan. So, should we really call it an S-REIT or should we call it a J-REIT? I am inclined to think of it as a J-REIT that has a PR status in the world of S-REITs. Foreign talent, you know?

So, if we want to compare apples with apples and if we take a look at J-REITs, we would discover that it is rare to find those with distribution yields of 6% or higher.

Of course, to really compare apples with apples, we should compare Saizen REIT with J-REITs which hold residential real estate. There are quite a few J-REITs holding residential real estate but here are some numbers from 3 such J-REITs with the second last column representing the annualised distribution yields.



Click to enlarge.
Source: Tokyo Stock Exchange.

So, in the world of residential properties J-REITs, Saizen REIT would look very attractive now.

Could we see Saizen REIT's distribution yield declining to become closer to what J-REITs are offering now? I don't know. I need a working crystal ball to answer this question. My bowling ball struggles but cannot make it. However, I do know that distribution yield will decline if DPU falls or if unit price increases. 

So, what should we as income investors do? We look at how the DPU could fall, given all the information which we have. When we do this, we are actually assessing the level of sustainability of the REIT's income. There is no point in wondering how high the price could go or is there?

Of course, if someone would prefer to invest in S-REITs with higher distribution yields compared to Saizen REIT, there isn't anything wrong with that. However, making investment decisions based purely on distribution yields would be somewhat myopic.

Related post:
Saizen REIT: Rewarding patient investors.