In my 21 June post, I list all the REITs I sold. In the final paragraphs, I explained why I kept Daiwa House Logistics Trust (SGX:DHLU) in my portfolio. However, after some thinking, I also sold this last remaining REIT.
On 3 August 2023, Daiwa House Logistics Trust presented its financial results for the first half-year of 2023. Link to the PDF of their presentation. The REIT is doing well, with 100% occupancy of its properties reached. The income growth looks satisfactory in Japanese yen terms, while the already low leverage has dropped even more. We can almost conclude that DHLU is a worry-free REIT until we reach the last part of the presentation. Management presents 28 pipeline properties suitable for inclusion into the REIT: 16 in Japan, 12 in Vietnam, Malaysia and Indonesia. These properties are all built by the REIT sponsor Daiwa House Industry Co., Ltd. This is the first time management included such a detailed list of potential acquisitions in its presentation. The message is clear: we can expect acquisitions from this pipeline shortly. This realization made me reconsider my holding.
As we know, REITs have to finance new acquisitions by issuing new debt or equity. I am not excited about the idea of a rights issue. The share is currently priced at P/B = 0.74, which means a rights issue near the current stock price will be dilutive for the existing shareholders. Let's start with a general observation about P/B ratios. The book value of equity is often prone to manipulation by management, for example, by not writing down goodwill or inventory entries to reflect reality. However, DHLU's assets are modern, fully tenanted warehouses with straightforward valuations. Therefore, I consider DHLU's book value per share a good estimation of the value per share.
Consequently, when DHLU would issue new shares at P/B = 0.74, it essentially sells a dollar for 74 cents. Warren Buffett buys back shares of Berkshire Hathaway when they are below his estimation of intrinsic value in order to create value for the company. Issuing shares below intrinsic value is the exact opposite and destroys value. Of course, I could participate in a DHLU rights issue to profit myself. However, my existing shares will still be diluted in value. My net benefit will be negative unless I buy a whole bunch of new shares. That would equate to doubling down, a dangerous psychological rabbit hole which I always avoid.
Will management wait until P/B = 1 before expanding the REIT? I doubt it. DHLU was initiated by its sponsor, Daiwa House Industry Co., Ltd., a prominent Japanese developer. The latter's incentive is creating a vehicle to purchase the warehouses it builds. The developer can then use the sales proceeds to build more properties, which is its primary business. The sponsor is not in the business of offering an optimal financial product for third-party investors. Of course, this observation applies to most REITs, and legal restrictions are in place to regulate the resulting conflicts of interest. However, it's good to be clear about the sponsor's incentives. Daiwa House Industry Co., Ltd has a stake of only 12.5% in the DHLU. The Related Parties Shareholding is one of the few weaknesses REIT-TIREMENT flags in its analysis.
Lastly, I have some concerns about this REIT's momentum. The REIT is among the last to be listed during a long Singaporean REIT glory period. The overall sentiment around REITs has turned more negative lately. DHLU's investors are mainly Singaporean private retail investors. We know this from the Annual Report 2022, in which a list of the Twenty Largest Unitholders are mostly nominees connected to retail brokers in Singapore. Private retail investors generally don't hedge currency risks. This means DHLU's share price is susceptible to the JPY/SGD exchange rate. Exchange rates are impossible to predict.
Adding to its fragility, DHLU has a modest SGD 400 million market cap. It's hard to see how DHLU would leap to the premier league of large REITs suitable for institutional investors other than by issuing shares and acquiring warehouses. Lots of them. Perhaps all the 28 pipeline properties. However, as explained, I do not support such rights issues. Not to even talk about issuing debt, which can be even more risky considering the current interest rate environment.
In summary, we have a paradox. DHLU needs to grow, but I don't want them to expand. Damned if they do, damned if they don't. I chose to step aside.
Disclosure: Sold out Daiwa House Logistics Trust (DHLU)
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