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Income investors will probably know that investing in real estate investment trusts (REITs) is one of the most effective methods for ensuring a stable and consistent stream of passive income – in the form of tax-free dividends.
REITs offer not just stability of income from multiple leases, but they also allow an investor to attain diversification as REIT portfolios contain a mix of properties.
The hallmark of a well-managed REIT is one that manages to grow its portfolio as well as distribution per unit (DPU) over time.
Growing DPU is the reason why investors embrace the best REITs in the market, as this means their passive income also continues to grow along with inflation.
Here are three of the best ways that REITs can grow their DPU, along with some suitable examples for readers.
1. Positive rental reversion
Rental reversion refers to the renewal of expiring leases by existing tenants at a rental rate that is either higher or lower than the previous rate.
Positive reversion is good news for a REIT as it means that rentals are on a rising trend, while negative reversion usually points to lower demand for space within a property or maybe a result of an over-supply situation. If a REIT regularly reports positive reversion, this indicates strong leasing demand for its properties.
Link REIT (SEHK: 823), in its FY 2019 presentation slides, reported strong overall rental reversion of 22.5% for the year. In its prior year (ended 31 March 2018), the rental reversion was equally strong at 29.1%.
2. Asset enhancement initiatives
Asset enhancement initiatives, or AEIs, are undertaken by the managers of a REIT to enhance or upgrade the properties. These ensure that the properties are refreshed on a regular basis, providing customers with new experiences and offerings.
AEIs may also add in additional features such as a podium or façade for a building to enhance its attractiveness to potential tenants.
They are carried out in order to ensure the asset remains relevant, and the REIT can usually bump up the rental rates after the AEI is completed, thus benefitting unitholders.
Prosperity REIT (SEHK: 808), in its latest H1 2019 interim results announcement, reported AEIs being carried out at the Metropolis Tower (installation of lift card access system), Prosperity Place (installation of a projected type outdoor lightbox) and 9 Chong Yip Street (replacement of air-conditioning system).
3. Mergers and acquisitions
The third method for REITs to increase their DPU is to engage in mergers and acquisitions (M&A). By acquiring an asset with a net property income (NPI) yield that is higher than the REIT’s current dividend yield, the REIT enhances its return and can also increase its DPU.
Investors need to be discerning and ensure that the benefits of the acquisition include an increase in projected DPU, apart from other possible stated benefits such as diversification of the portfolio.
Sunlight REIT (SEHK: 435) concluded an acquisition of Fung Shun Commercial Building back in September 2017 for HK$658 million (US$84.6 million). The rationale for the acquisition was that it would increase projected DPU from HK 25.5 cents to HK 26 cents.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Hong Kong contributor Royston Yang doesn’t own shares in any companies mentioned.