Fraser Hospitality REIT vs Transformers

There was an article on the Fraser Hospitality REIT this morning. Interestingly, the yield reported is about 7%. If you compare the 7% REIT return versus the return that you are getting from the bank for your saving account, I bet you will be overwhelmed by the spread that you will be getting from this REIT. However, do take note that the gearing ratio of this REIT is close to 40%. Well, I have not read the prospectus. So, I cannot comment much about this REIT. But, I really think you have to be careful about some of the accounting that goes into deriving the dividend yield. Take the following for example.

Scenario	Gearing	Equity	Debt	Asset	Dividend	Dividend  per share	Price	Dividend  Yield
A	20%	$100	$20	$120	$5	$0.05	$1	5.00%
B	50%	$80	$40	$120	$5	$0.06	$1	6.25%

Assuming there is a REIT (Scenario A) with gearing ratio of 20% and dividend of $5, the dividend yield will be 5% for a share price of $1. In layman term, it means I borrow $20 from the bank and I get $100 from you to buy a building of $120. I get $5 as rental income which will be paid to you yearly for the $100 that I get from you.

However, under Scenario B, if I increase the gearing ratio (i.e. amount of debt from bank) to 50%, I can basically push up the dividend yield by reducing the amount that I get from you. Now, the dividend yield is 6.25%. The above is a very simplistic example with the assumption of interest expense for debt borrowing = $0. This is, of course, not ok because more debt means more interest payment. In the current ultra-low interest rate environment, it can only mean one thing in the near future - interest rate goes up and interest payment goes up. This will eat into your dividend return. Hence, it is very important not to judge a REIT just by its dividend yield.

I will probably spend my time watching Transformers 4 - Age of Extinction this weekend rather than looking into the details of this REIT. I think it will be more exciting. Anyway, always remember - "There’s more to them than meets the eye."