Private Equity Outlook for 2013-2015 (My View)

by September 04, 2013
Current Trends- Private Equity
2012: Stuck in the dreary storm
It is well known that 2012 was not the best year for the private equity and venture capital markets.
Buoyant by the year-over year (2010-2011) increases in the overall level of US deal flow volume and capital invested; many private equity professionals chose to express optimism at the start of 2012 despite the fact that global buyout market still remained flat since 2010. Pension funds and insurance companies found it difficult to commit capital given that there were hardly any pickup in investments and exits. Their optimisms were quickly muted as political and regulatory uncertainty rose in the U.S., the reemergence of Eurozone’s economic troubles and the pessimism over how India and China would ‘land’ their heated economies contributed to an unexpected decline in global buyout deal flow  amounting to a disheartening $186billion ($246-$696 billion pre crisis) by the end of 2012.
 A Global Update 2013: Amidst the dark clouds
 At the start of 2013, GPs across the global are still saddled with huge amounts of dry powder accumulated since the downturn. The notion of “too much money chasing too few deals” holds true even in the Global Private Equity market and made serious by the following economic predicaments
i.   Europe still held back by economic uncertainty; will continue to drive a wedge between buyers and sellers. The IPO channel is expected to remain dormant in Europe.
ii. China and India; the two countries most sort after for  private equity investments have experienced disappointing economic growth, increasing competition from other PE firms and unstable politics. Searching for good deals in both countries will continue to be a challenge.
iii. Australia, is entering a period of heightened risk and vulnerability as global commodity demand wanes
iv. In Japan, the devaluation of the yen may add some short term relief to the nation’s deflationary conditions, but, it is by no means a long term solution. Investors will be battling the powerful headwinds of an aging population and high government debt.


GPs holding aging dry powder still face many challenges brought over from 2012 and are eager to put their capital to work, so as to prevent a maximization or extension of holding periods which pushes down returns for LPs; affecting the relationship between both parties. But where else can GPs put their capital to work?
Pockets of opportunities: Growth drivers
Despite a sea of negativity in the global economy, Asia-Pacific (excluding Japan & Australia) seemed to have invoked bullish expectations and interest from many professional PE firms and LP investors. These are some of the reasons;
Asia-Pacific’s economic growth is fueled by rapidly improving standards of living, a healthy household savings figure and a growing middle class. This in turn also gives rise to many potentially local businesses for cash rich PE firms to fund and mentor. The overall low PE penetration in the region further supports PE financing   for local businesses.
Exit opportunities are also abound in the region. PE firms who invested early into Asia-Pacific for the last 15 to 20 years, are expecting more global companies to step up their acquisition. 
activities in Asia Pacific and buyout holding companies as they seek to expand into high growth markets and solidify their comparative advantage. As such, exits to strategic buyers are expected to be more likely than exit via IPO for Asia-Pacific.

The PE investment trend in Asia Pacific to note
The private equity industry in Asia-Pacific continues to evolve; instead of just providing financial support, the current investment trend now in Asia Pacific is that PE firms are more focused on ‘value creation’ -the use of internal operating partners to drive value creation in portfolios. Many PE firms in Asia Pacific insist on partnering with the management, providing needed technical expertise, resources, networks and structuring proper governance to grow the business together instead of than leaving it to run on its own.

4. Pockets of opportunities: The specifics
Country specific: Vietnam
Vietnam has not been investors’ first choice to deploy capital due to its past weak economy performances and high inflation— but what the country lacks in economic glitter; it more than makes up for in stability. The largely homogenous population and established political regime have created a degree of improved confidence and calm. Vietnam as a whole is hungry for capital; their financial sector is not well established and their private sector is not well run. Many businesses need capital and expertise to reach the next level of business success. Sectors currently experiencing only lukewarm activity could soon start to see heated deal flow as GPs become embroiled with competitors for assets, particularly in the consumer goods, financial services and other non-exportable sectors.

Country specific: Myanmar
Myanmar is experiencing a new paradigm shift; turning away from its politically repressive past and embracing democracy and economic reform. The country is opening up to the rest of the world. Problems such as the lack of basic infrastructures –proper roads, power. The lack of financial intermediaries; an outdated banking system, presents a huge opportunity for businesses to look into. The growing manufacturing base and low cost labor factors are also likely to draw businesses looking for viable alternative markets to China. The resource-rich nation will likely see an expansion of investment, particularly in its banking, infrastructure, oil and gas sector for 2013 and the coming years.

Sector specific
Consensus among PE professionals expects energy, mining and utilities and consumer sectors to attract the most interest across Asia-Pacific. Other sectors like Industrials and chemicals and technology, media and telecommunications are expected to draw in significant interest as well.

Though it remains to be seen how the rest of 2013 will pan out for the private equity market as a whole. We at partners group continue to believe that there are pockets of opportunities, if one were to look closer. Perhaps we all can start by looking to Asia- Pacific as the engine to drive growth for the foreseeable future. 

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Religare Health Trust (RHT) value that bind or blinds?

by August 28, 2013

Religare Health Trust (RHT) value that bind or blinds?    

For the past few weeks I have been looking at health related securities, be it First REIT, Parkwaylife REIT, Raffles Medical, Biosensor etc. And then one afternoon while watching an amusing documentary on YouTube about how brushing your teeth with lemon grass can make it whiter; an advertisement popped up and Religare Health Trust came into view. 
When I took a quick look at RHT, its investment story was much sexier as compared to the rest of the previous health care related securities. Well some investors might say that reading RHT’s prospectus was like an equivalent to reading the Kama sutra.  But as the saying goes.  “If it sounds too good to be true, it probably is; that ‘Kama’ might just be a b****"
So in this post I shall list down the reasons why this business trust is inherently attractive to value investors like me and some of points to take note of while investing in this business trust

The basics
Religare Health Trust (RHT) is an integrated healthcare delivery provider in the Pan Asia-Pacific region. RHT is a business trust with a portfolio that consists of healthcare assets in India.
Listed on SGX mainboard September 25th 2012; raised over $SGD500 million, of which 95% of the proceeds will be utilized to fund the initial portfolio consists of 11 clinical establishments (S$714mn), four greenfield clinical establishments (S$29mn) and two hospitals managed and operated by RHT (S$5mn), which are all geographically diversified across India. Their auditor; Ernst & Young LLP.
An update, RHT has now (as of July 25th 2013) 11 Clinical Establishments worth $737m, 4 Greenfield Clinical Establishments worth $31m 2 hospitals managed and operated by RHT worth $5m. Greenfield means “yet to build”
Their Singapore office address is at #11-20 UOB Plaza 2, 80 Raffles Place

The attractive points

Country/Industry attractiveness: Many RHT reports starts of by saying that India's healthcare sector is set for growth, driven by rising disposable income as well as increased healthcare awareness. India aging population growing by 24.4%, huge healthcare demand/supply gap, growing affluence of 7.8% CGAR from 2013 to 2015, the average lease terms of healthcare assets long term 10-18 years (RHT’s average lease is 15 years- with the view of renewing for another 15 years) and so on. Healthcare is a defensive sector that should be cash generating in all times and so on. Much has been said about the attractiveness of the country and industry, but can RHT capture this growth? My take is, somewhat likely- do continue reading

RHT policy positioning: RHT is positioned to benefit from a rise in India's healthcare revenues via its current fee structure which allows it to share into underlying hospital revenues. With a based service fee consisting of fixed quarterly payments with 3% escalation per annum- upward revision for any capex/ expansion and a variable Service Fee consisting of 7.5% of the Fortis Operating Companies’ Operating Income for each quarter simply enable RHT to capturing the growth of the hospitals through a fixed fee and the sharing of operating profits. But is their assets (hospitals, clinics etc) well located? Just like investing in a REIT, the location of where the building is, the catchment area, potential new supply in the area, façade, size, age of the hospital, the income growth in that area and whether the asset provides a need or a want to the targeted customers is vital to how a REIT will perform. I did due diligence on this part and this is what I have found

RHT asset positioning: Because I am now actively looking for a career, I cannot simply take off to India and visit all 17 properties diversified all over India. If I could, I will, but luckily there is something called google maps and I used it to my advantage by checking the location of every single properties that RHT has acquired. What I looked out for is city or factory activities near the clinics (the foundation of health care demand), whether it is easily accessible- be it high ways, roads, etc (the convenience factor) and the current competitors in the area. I like most of the assets that RHT bought, moreover during the AGM held on july 25th 2013, the management was questioned on their knowledge and ability to pick good yield accretive assets in India; I was satisfied with their answers, nonetheless. However there were still some buying decisions that bothers me, which I will elaborate further under the “the un-attractive points)   

RHT asset organic growth: Recall that RHT has a variable fee component; 7.5% of operating fees. This means that, if more beds are built per clinic or hospitals, more income can be derived for the unit holders assuming that there is demand for such beds.  A quick observation reviews the following; RHT has about 1870 potential beds (yet to be installed) and 3197 installed beds (just built).  Revenues from FY 12 to FY 13 have increased on average about 15-16%, lowest 7% which is in Nodia and highest 55% in Shalimar Bagh.

Low Gearing:  As of July 25th 2013, RHT gearing is 8.9%, which is low as comparison to peers (Like First REIT , Parkwaylife). RHT has an estimated “debt room” (means can borrow, but doesn’t mean it will or able to borrow) of about 350million. Cost of debt is 4% for RHT. This is one of the points excited me greatly, because financially; RHT has yet to leverage effectively to increase its NAV and DPU. RHT’s has target gearing of 30%-40%, about S$250mn to S$400mn of debt headroom could be deployed to finance the capital expenditure. Comparing with other related securities Ascendas India Trust has a gearing of 33.0%, Parkway Life REIT 36.4% and First REIT 15.9%;
   
Strong sponsor:   One of the key risks in investing in healthcare REITs is the idea of counter party risk; such that the master lease agreements are only as safe as the strength of the counterparty, example if Lippo Karawaci collapses First REIT I think will collapse as well, as the former contributes 90% of First REIT’s revenue. Likewise for RHT, Fortis Healthcare is the sponsor and looking at the sponsors balance sheet and business health, I find the following. As of March 31, 2012, Fortis operated its healthcare delivery network in India, Australia, New Zealand, Hong Kong, Vietnam, Singapore, Mauritius, Dubai, Sri Lanka and Canada with 75 hospitals, over 12,000 beds, over 600 care centers, 191 day care specialty centers and over 210 diagnostic centers. On April 27, 2011, it acquired Escorts Heart Institute and Research Centre Limited. Over the last five years (FY07-12), Fortis Hospitals have delivered an organic CAGR of 21%. Fortis also has 28.0% stake (220.7 mn units) in RHT 

Foreign exchange risk: No longer a concern as forward contracts were used hedge the currency risks until March FY 2015

Attractive yields and ratio comparable:  At a share price range of 0.85- IPO 0.9- highest 0.98 cents, taking into account 100% distribution payout over Forecast Year and Projection Year. Sponsor distribution waiver over Forecast Year and Projection Year, the expected yields for FY2014 would be around 9.2% at 0.85 share price, 8.8% at IPO share price and 8.1% at a share price of 0.98 cents. Comparatively First REIT’s yield is around 6.3-7% and Parkway is around 4-5%. RHT’s NAV per unit is $0.91 thus PTB would range between 0.93 or 0.98 or 1.1   

Now for the unattractive points:

Country attractiveness gives raise to concentration risks: 

The initial portfolio is located in India, which exposes RHT to country concentration risks. RHT’s hospital occupancy can fall in the event of a downturn in India’s healthcare sector, political strive and therefore adversely impact RHT’s revenue and depreciation in property value of RHT’s portfolio. In addition country's attractiveness is very dependent on how India's economy is doing in general; why? Because RHT target market is the (if im correct) middle to upper class patients. With the onset of current weakness, high current a/c deficient, government refusal to improve on productivity and protectionist policies, it brings into question the expected growth of the middle income people in India.    

Questioning the Industry attractiveness/ asset positioning: There is a popular idiom that says that you can attract more flies with honey than vinegar, but I say that you can catch even more files with manure than vinegar or honey!  You see, every analyst report on RHT I’ve read, attempts to persuade investors by starting off with  rosy complements on how very attractive the healthcare industry that RHT is in, that there is lots of growth, lots of demand and so on. But if you dig a little deeper, you will find that every hospital or clinic that RHT has bought is either near another competing hospital or clinic. And it’s not just one or two hospitals or clinics that competes with fortis, there are as much as 6-10 of competitors vying for patients. Like for example; when I looked at Fortis Malar Hospital on No 52, First Main Rd, Gandhi Nagar, Adyar there is another 6 other hospitals within a radius of 10kms (see figure 1) and when I google map hospitals in Chennai”, I got a ton of other clinics and hospitals, popping up like chicken pox in the same area (see figure 2). The question I would ask myself is, how is RHT going to compete with so many competitors like Vijaya Hospital; Apollo Hospital, Manipal Hospitals and and to a lesser extent, government-owned hospital, smaller private hospital groups and new entrants; and if they are able to compete effectively with these competitors how do I tell?

I answer my own question, by placing a small sticky note on their annual report saying “check their occupancy rate and operating margins- there has to be an increase!” 

Figure 1:

Figure 2:
Figure 2 notes: One way to tell whether the hospitals are well maintained, is to check the car park of the building; if that is well maintained, so will be the rest of the hospitals! What I found out is in India, just like Indonesia, if you are from the middle class, going to a public hospital when you are ill is not an option. The public hospitals are crowded; people from all over India come to government hospitals (cause it is cheaper)  so you have people camping all over the corridors, on the staircases, they bring their families and their extended families. So for the middle to upper classes, going to a public hospital is not likely as the que is very long as well.

From the prospectus, it says that the there is a yield waiver period; that the sponsor will not take their entitlement on the 100% net property income distribution payout for both FY13 (Mar) and FY14 (Mar). I am quite certain that this policy acts as a sweetener to potential investors to buy into RHT’s IPO. But from FY15 onwards, hear this… there will be no more sponsor waiver and the payout drops to 90%.
So let’s assume that, RHT is able to meet the forecasted dividends for FY2014 at ~9.6%. Assuming they sustain revenue into FY15, and taking into account -2.5% when sponsor waiver lapses, and payout drops to 90%, the dividend then falls to 7.1% from FY 15 onwards.

By stripping out the distribution wavier, RHT’s yield drops to 7.1%. So Is 7.1% an attractive yield? I look at an immediate alternative, the India 10 year government bond, yielding around 8%.  Wouldn’t the latter be a better alternative? Some argue that RHT yield can continue growing and that the government bond cannot. So a lot depends on RHT’s utilization of debt and whether its hospitals can perform as they claim to be in their prospectus. But if RHT cannot deliver its promises, man! Unitholders are left with quite a bad bargain.

On valuation
CIMB securities research indicated a IV of $1.07 (as of June 2013), the valuation method used was pro-forma income statement with a Gross Property Revenue of $SGD 146m and a distributable profit of $SGD 67.49m by march FY2016. One thing to take note of, is that by next year FY2014, the CIMB analyst expects RHT to deliver a core EPS growth of 174% and if RHT cannot deliver this promise, the IV will fall. An overall analysis of the CIMB analyst’s valuation method and on its IV of $1.07 per share for RHT, I would say it’s either a conservative or she doesn’t know what she is doing. Some readers might question me, why the analyst bashing again? Simply because in FY2014, the analyst forecasted a Distributable Profit of $SGD 46.56million out of  $SGD 66.24 million Net Property Income; this represents only a 70% payout policy for FY2014; but recall that in the prospectus the agreement was a 100% of the net property income for FY 2013 and FY 2014? Perhaps I’m wrong with some accounting definitions; but until someone corrects me, a target price of $1.07 is not a reliable price I would base RHT on.

How I would value RHT is simply giving it a unit price range. For RHT’s upper bound ( the optimistic case- how much RHT unit price can go up to) I would use first REIT’s PTB multiple by an estimated no. of years RHT can reach first REIT’s standard, while adjusting the NAV (by taking out 100% of the intangibles) for RHT’s lower bound (the pessimistic case-how much RHT unit price can fall).  
Let me explain further,

For RHT’s upper bound, I would use First REIT’s latest PTB multiple and multiply it to RHT’s net asset value in 4 years’ time. Why use First REIT? Cause environment which First REIT’s properties are on, the way the management fees are structured as well as the strategies used to acquire properties is very similar to that of RHT, to me RHT could be another young First REIT if you will.

Why 4 years? Cause it took First REIT’s management about 4 years (not considering 2008) to build that reputation, to show results, to meet or exceed expectation and again confidence with investors in order to garner a unit price of $1.225 (as of July 2013) which represents a PTB multiple of 1.36 times.
Applying the law of conservatism, let just assume that in 4 years’ time, RHT net asset value per share is  just $1 (currently it’s 0.90), I take 1.36 times multiply by $1 and get $1.35 per share in 4 years’ time. I discount $1.36 by a discount rate of 10% and added in the dividends for the next 4 years (using the CIMB forecasted dividends FY2013: 0.03, FY 2014: 0.082, FY2015: 0.081, FY2016: 0.085) I get an upper bond IV of $1.25.

So in a nutshell; RHT’s unit price can reach $1.25 provided is can deliver its results, give investors the confidence, such that in 4 years’ time the unit price is worth $1.35 and it delivers 4 years of dividends 0.03, 0.082, 0.081 and finally 0.085 by 2016. Then RHT’s unit price is thus worth $1.25  

For RHT’s lower bound share price; this is how derived it
I took RHT’s Net assets as of march 2013: $SGS 714,510,000
Less off its Intangible assets: $SGD 149,594,000 divided by
Total shares: 788,131,944 and get

An adjusted NAV of $SGD 0.716

In a nutshell, I still think RHT is a 'potentially' great REIT to buy into, however do note that if the latter cannot deliver, it means that the intangibles such as the “name of having Fortis on its hospital front” has little or no value to me and it’s unit should be worth around $SGD 0.716. It could go even lower if, RHT’s competitors take the bulk of the market share. 

As of 28th August 2013: RHT is now at $0.755. The good news is, that most of the economic woes of India should be priced into $0.755

Verdict: Buy with caution



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How to analyze real estate developers

by April 28, 2013


Real estate stocks make up a significant number of companies in Asian stock exchanges and many of them are among the the most volatile stocks. Whether the real estate developer is listed or not, they are influenced by a host of cyclical factors ranging from government policies, interest rates, unemployment rates, affordability, etc. Hence, it is important to understand how real estate companies can be analyzed.

Profit Model

Real estate industry can be separated into the following sub-industries or types of real estate developers:
  • Residential real estate developers
  • Commercial and mixed use real estate developers
  • Industrial real estate developers

Profit model of residential real estate developers

Residential real estate developers are more dependent on economies of scale than ever because of increasing land prices and declining rate of increase in residential property prices. In many developing countries, developers used to be able to acquire land at cheap prices and hope for rapid increase in home prices to make huge profits. In developed countries, land prices are higher, and price increases are more muted. Hence, brands and good management are playing an increasingly important role.

Profit model of commercial real estate developers

As prime real estate for commercial developments become more scare, commercial real estate developers tend to prefer to have rental incomes rather than selling units so that they can have consistent income and manage the properties. These developers are also more likely to sell their commercial properties to real estate investment trusts to free up capital and many are REITs that also develop properties.

Profit model of industrial real estate developers

Industrial real estate developers operate more like commercial real estate developers as they seek to have stable rental incomes and also sometimes selling their properties. Some industrial estate developers might even have a fund to invest in promising industrial companies so as to achieve higher profits.

Factors that Affect Value

  • Land bank - the value of a real estate developer is directly influenced by its land bank. As the larger the land bank, usually means the developer can make more profits from developing the land banks later. Hence, the land bank that a real estate company has is always disclosed in detail in the listed companies' reports.
  • Inventories - Real estate inventories an be separated into a few categories. Usually increasing values of construction-in-progress and land held for development will translate to higher future earnings for the company:
    • Completed developments - properties whose construction has been completed
    • Construction-in-progress - means the value of properties under construction.
    • Land held for development - value of land help for future developments.
    • Investment properties - properties held for rent or sale
  • Customers deposits - for residential projects, it is often that developers will collect customers deposits or even prepayments of entire houses prior to completion of the units. As these properties are pre-sold and their profit and loss have yet to be recognized in the income statement, growing customer deposits could signal increasing revenue and most likely profits in the coming years ahead.
  • Housing prices - the profits from real estate developers that primarily sell their developments come from selling the units at above costs. Hence, the moving of housing prices have direct impact on the profitability of residential real estate developers. Usually the stock price of real estate developers have high correlation with the anticipated housing price direction.
  • Rental rates - Rental rates are especially important for commercial and industrial real estate developers as most of them do not sell all the units that they developed but they keep these units for rental returns. Rental rates have direct bearing on stock prices of such developers and REITs.
  • Industry consolidation -  as economic difficulties mount and economies of scale becomes more important, mergers and acquisition activities will also drive prices of real estate companies as the merged entities might be more efficient given a larger land bank.
  • Macro economic factors - government policies play a huge role in controlling property prices as the following factors will determine the direction of property prices. We have listed
FactorMovementLikely Effects
Interest ratesUpNegative
Land supplyDownPositive on short term price but will affect future profitability if land bank dries up
Loan QuantumUpPositive
Reserve ratioUpNegative
GDPUpPositive
UnemploymentUpNegative

 

Valuing Real Estate Developers

A common method to value real estate developers is using the Revalued Net Asset Value ("RNAV") approach which basically determines the net asset value of a real estate developer by adding up the change in value of the investment properties held by the company, the surplus value of properties held for development using Discounted Cash Flow method and the net asset value of the company with any other adjustments that are deemed necessary.
Usually a discount or premium percentage is multiplied with the RNAV base on the developers other qualities such as management capabiltiies, branding, track record, etc. A smaller developer with poor record of continuously generating consistent income is usually given a significant discount to its RNAV.
Using the RNAV approach only takes into account of what the developer can earn with the assets that it has in its books at the time of the valuation. If properly applied, it is usually more conservative than the market approach such as P/E multiples.
However, to use this method, it requires a lot of work in revaluing the properties held by the developer, making it difficult to implement by most people as information needed to determine RNAV needs some skill in obtaining.
The price earnings ratio method could also be useful to cross check the RNAV method.

Source: http://roccapitalholdings.com/content/how-analyze-real-estate-developers

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Maximizing gold returns

by February 22, 2013


Dear Readers, Today my friend and I were discussing and arguing about an interesting topic on gold investing and how a gold investor can maximize returns using the power of options. Being a firm believer in equity investing, I hope to spot any loop holes in his gold strategies- in short this is what we discussed; There are many people out there waiting to invest their money into gold at their desired price; so in order to help these people enter the game, they can actually do the following besides waiting on the slide line for gold prices to drop. Step 1: Write (sell) a Put option at a strike price that you are willing to invest, that way you can earn cash income even if gold continues to raise instead of just waiting on the side lines. Etc: Gold ETF is now at $23, You can write a put option at $22 which is your desired price to enter gold. If gold continues to rise, the put option which you sold will become worthless and expire, in return you collect the cash income from the sold option; keep on doing so, if gold continues to rise and earn fees from there. The downside of course is if gold falls, You have the obligation to buy gold at $22 instead of the current market price which is cheaper to an unknown extend. But is somewhat of a good news to you, because you have now bought gold at your ‘desired’ price (albeit at a higher price) and you can activated step 2 Step 2: Now that you have bought gold at $22, your main objective is to sell gold for more than $22, so you set your desired selling price at $23 again. What you can do is lease your gold out, in the form of writing a call option at strike price $23; in others words what you are trying to do is, you promise to sell back gold to the counter party at $23 should gold price raises. If gold price rose to $23 or above, the call is exercised and you have to sell your gold at $23 or higher. Essentially you would have cash out everything and go on to repeat step 1 again. If however gold prices where to fall some more, you can activate step 3 Step 3: Buy gold at that fallen market price and write call option again and wait for gold to go up. So dear readers, what do you think are the risks to this 3 step gold investing strategy? It seems to me like interesting investing plan that rewards investors with high returns and low risk.
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The glory of REITs

by January 07, 2013




You probably have heard or read about REITs (Real Estate Investment Trusts) before? If you haven’t, you don’t know what you’re missing out! So for the benefit of those who don’t know about REITs, they are basically just like stocks trading on SGX, but instead of referring to them as “stock” the proper term is called “units”. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
Individuals such as you and me can invest in REITs either by purchasing their units directly on an open exchange or by investing in a mutual fund that specializes in public real estate (Etc Lion Fund, they invest into a group of China related REITs)

So let's just touch a bit on the "sciences" of valuating a REIT.

1) Many people I know in the industry, uses the Discounted Cash Flow (DCF) model to value a REIT. This model assumes a certain rate of growth in cash flows over a certain period. This is then discounted back to their present value (PV) at an appropriate interest rate that reflects the weighted average cost of capital (WACC) of the REIT, for those who attended MIP advance would be well aware of this model. But perhaps in my opinion, a better valuation model for valuating REITs, is to use dividend discount model (DDM), due to the fact that REITs in Singapore are required by law to pay off 90% of their earnings back to unit holders. Wouldn’t then this be a clear indication of using DDM instead of DCF, since dividends is the one that unit holders are getting back instead of cash flow? This is debatable, nevertheless I shall move on. 
  
1) Many people I know in the industry use the Discounted Cash Flow (DCF) model to value a REIT. This model assumes a certain rate of growth in cash flows over a certain period. This is then discounted back to their present value (PV) at an appropriate interest rate that reflects the weighted average cost of capital (WACC) of the REIT, for those who attended MIP advance would be well aware of this model. But perhaps in my opinion, a better valuation model for valuating REITs, is to use dividend discount model (DDM), due to the fact that REITs in Singapore are required by law to pay off 90% of their earnings back to unit holders. Wouldn’t then this be a clear indication of using DDM instead of DCF, since dividends is the one that unit holders are getting back instead of cash flow? This is debatable, nevertheless I shall move on.   

2) The Book Value method is another way to value a REIT, this method attributes a certain discount or premium to a REIT’s book value (book value or revised net asset value is the latest valuation of all the properties owned by the REIT minus its liabilities), so some people just use the BV as a signal to buy when the unit price fall below the BV by a certain percentage and likewise sell when the unit price rises above the BV by a certain percentage.

3) Cap rate or yield, the third way to value a REIT, which is the annual net property income (NPI) is capitalized at a certain yield thought to be appropriate for the REIT. Some analyst uses the yield as indication to buy or sell. For example, In 2004 to 2007 when the stock market was booming, many of the REITs were trading at a high valuation and had yields that were quite low

While all the above methods are intellectually correct, they are not of much use to an investor if the fundamentals behind such assumptions are not clearly understood. Hence i believe it is far more important to understand the factors that drive up value of a REIT rather than obsessing about precise values churned out by financial models.

So without further ado let’s look at the “art” side of valuating REITs
The main pointers are 
+The potential for capital value growth (CVG)
+Capital structure of the REIT and the caliber of its managers

Capital Value Growth (CVG)
There are several factors that need to be in place for the a REIT to appreciate in value, let's use Capital Mall trust to illustrate. A Key factor is to ask yourself whether the trend of suburban shopping activities will continue to go up since such activities will result in high occupancy rates and increase rentals at suburban malls, in turn driving up the capital value of the REIT. A reasonable investor would then need to make intelligent guesses (supported by industry research/ expert opinion) and form his or her own opinion on the industry trend for that particular REIT. 

 On the supply side, the investor would need to form a view on the potential for new supply and the government policy regarding releasing land for malls in the suburbs. This question can be then answered with a good degree of conviction if the reasonable investor does his homework, like studying the potential land marked for commercial development in the suburbs and history and pattern of commercial land released in the past. Were there cases of over-supply in the suburbs in the past? If so, what led to it? Was the catchment area (the area and population from which a facility or region attracts visitors or customers) not large enough? Can this happen in the future?

Another factor is replacement cost, can a new mall be built in the future at a cheaper rate? Unlike the high-tech industry where new technology has historically led to lower costs for components and gadgets, real estate on the other hand is a fairly staid (fixed, settled, or permanent) industry where construction costs usually trend upwards, driven by the increasing cost of labor and materials. So the cost element is unlikely to lead to big surprises in the future. This is not an exhaustive list and there might be several other factors depending on the specific Reit. However, the general principle is the same. Understand the factors that lead to capital appreciation and you will gain good insights into the valuation of a REIT.

Reit Capital Structure and management

Asset values and rental growth can be quantified and directly impact a Reit's valuation. However that does not mean one should ignore qualitative factors just because they cannot be put in a financial model.

Keep in mind that a Reit is not just a collection of physical assets but is operated by managers. It is precisely the ability of management to add value to the assets that makes the Reit model attractive.
I give you three most important qualitative factors out of the many i have discovered in valuing a Reit:

1) Leverage and interest coverage: One should tread carefully if a Reit has low interest coverage as it can easily run into trouble if rentals drop (etc Fraser Commercial Trust). A reasonable investor should be convinced that rents are sustainable before committing to such a Reit.
2) Ability to raise financing: Reits that can raise financing from a variety of sources deserve a premium, as you can sleep peacefully knowing that banks and the big boys (investors with large pockets, or funds) believe in the Reit.
3)Management caliber  If the management is able to consistently increase values through asset enhancement, prudently acquire assets and consistently deliver growth in distribution per unit with out taking undue risks, then it also deserves a premium.

Don't buy a Reit which has already priced in acquisition driven growth. This is one of the most frequent cases of disappointment as growth through acquisitions is the most risky route and only works during depressed times. A particularly risky time for acquisitions is the current period where interest rates are abnormally low. This tempts many Reit managers to borrow cheaply to acquire. However, the "yield accretion" in such cases comes from the low interest rates rather than attractively priced assets. As such, the accretion will likely disappear with the next refinancing. There is no single formula or model where you can plug in all the variables and get a precise valuation. One needs to understand a variety of factors to get a sense of a Reit's valuation

But hold on a minute!
According to Ms Teh Hooi Ling, senior correspondent of Business times,
The high yields of real estate investment trusts (Reits) are tempting. And indeed, they have been touted as a relatively safe and stable instrument to own if one is looking for a steady stream of income. As such, many investors see Reits as a good asset class to have in one's retirement accounts.
But you know what? That Reits are good income-yielding instruments is but a myth. The thing is, whatever they pay out in dividends, they will take back - all and more - a few years later in the form of rights issues.

Here's what I found. Of the 17 Reits which have a listing history of at least four years on the Singapore Exchange, only three have not had any cash calls or secondary equity raising. The remaining 13 have had cash calls, and many had raised cash multiple times. One had a few rounds of private placement of new units which diluted the stake of existing unitholders somewhat.
For many of these Reits, the cash called back far exceeded the cash received. So, the myth of Reits as almost comparable to a fixed income instrument is really busted.
Take CapitaMall Trust (CMT) which was listed in July 2002. Assuming that Ms Retiree bought one lot or 1,000 units at the initial public offering (IPO) for a total sum of $960. For the whole of 2003, she received $57 in dividends. However in that year, CMT also had a one-for-10 rights issue. To subscribe for her entitlement, Ms Retiree would have to cough out $107.
In 2004, she would received $89 for the total number of CMT units she owned. That year, CMT had another rights issue, also one-for-10. The exercise price was higher at $1.62. To subscribe, Ms Retiree would have to fork out $178.
In 2005, CMT again had another fund raising exercise via rights issue. Ms R would pocket $124 in dividends but in that same year, had to return $282 back to the Reit.
In the next three years - 2006 to 2008 - Ms Retiree felt rich and happy. She merrily banked in her quarterly distributions which amounted to $404 for her holdings of CMT. Her one lot, after three rights issues, had grown to 1,331 units.
In the following year, another $175 was distributed. But CMT wasn't going to let Ms R be happy for long. It launched a big one - a 9-for10 rights issue. To fully subscribe for her entitlement, Ms R had to empty her bank account of a whopping $982.
And you know what, the cash call came in March 2009, when the Straits Times Index fell below 1,600 points, and many retirees were dismayed to see their investment portfolios plunge by half or more. Many fret if they would have enough left in the pot to sustain their lifestyle. Having to cough up more money for a Reit was the last thing that they wanted to do!

Negative cash flow
And here's the final tally. Since its IPO until today, a holder of one lot of CMT would have received $1,264 in cash distributions. However, in all, he or she had to return $1,549 back to the Reit so as to subscribe to their entitlement of new issues. That's a net outflow of $284 per lot.
It's the same story with K-Reit Asia, Capitacommercial Trust, Frasers Commercial Trust, Mapletree Logistics, First Reit, Lippo Malls Indo Retail Trust, AIMS AMP CAP and Saizen REIT in that what was taken back from investors was more than what was given out.
K-Reit has been one of the most aggressive fund raising Reits. Had you started with just one lot when it was listed in April 2006, you would have to dish out $8,399 to subscribe to your rights issue. Distributions amounted to $1,110, resulting in a net outflow of $7,289.
For Reits with at least four years of track record, only Fraser Centrepoint, Parkway Life and CapitaRetail China have not had any cash calls.
Instead of a rights issue, Suntec Reit raised funds by issuing new units to some institutional investors at a slight discount. Existing unitholders don't have to cough out additional cash, but they would have their share of earnings diluted somewhat

Misalignment of interests
Reits are managed by managers, and managers are paid based on the size of the portfolio that they manage. So the incentive is for the managers to continue to raise money and expand the portfolio size. Sometimes this is not done in the best interest of unitholders.
The most recent controversy was over K-Reit's purchase of Ocean Financial Centre (OFC) from its sponsor Keppel Land. K-Reit has launched a 17-for-20 rights issue to pay for the purchase which was deemed by the market to be expensive at a time of uncertain outlook and when office rental is expected to ease.
BT reader Bobby Jayaraman argued that rather than be compensated based on factors such as the value of assets, net property income and acquisition fees, Reit managers should be paid based on a combination of growth in distribution per unit and market valuation of the Reit.
'If Reit managers were paid on the basis of distribution per unit and market valuation growth, would K-Reit have bulldozed its way through the OFC acquisition like they have done?
'The day K-Reit announced the OFC acquisition, its stock price fell close to 10 per cent and has continued sliding. Yet, its Reit manager will take home significantly increased management fees while shareholders would have lost a good chunk of their capital even as they bear significantly more risk in the form of higher leverage and potential property devaluations given the uncertain environment,' he wrote to BT.
Misalignment of interests aside, there are also unitholders who clamour for growth.
But while Reits may not be the perfect income yielding instrument that they are made out to be, they have proven their capacity for capital appreciation. Relative to the capital ploughed in, CapitaMall Trust has rewarded its unitholders with a return of 127 per cent. Most Reits have yielded positive total returns.

Instead of buying Reits for yields, some savvy investors only buy them when they see those with good quality assets trade at sharp discounts to their book value. For example in the first half of 2009, CMT was trading at 50 per cent its book value.

Hence, valuation metrics which apply to a typical asset heavy stock would apply to Reits as well.
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