This is a continuity post from my previous post - How do I Conduct Fundamental Analysis for REITs? in which I have brought up the idea of using yield factor as a discount factor for the dividend yield to get the fundamental intrinsic value. I have shared this idea previously in 2019 - REITs Valuation post. Besides fundamental valuation, I would also employ the reversion to mean method to gauge the favorable price, which is similar to the post of 9 Attractive SREITs Based on Mean Reversion. I would use a fiction REIT - BAO HUAT REIT as an example to better illustrate my thought process.

**1) Determine the Sector Yield & Market Cap Discount Rate**

First, let's set the benchmark and minimum dividend yield for each sector. The benchmark dividend yield refers to the target dividend yield for an average REIT in terms of fundamentals (REIT with a yield factor of ONE). Minimum dividend yield refers to the lowest dividend yield one could accept for a particular sector.

**2) Determine the Fundamental Intrinsic Value**

To determine the fundamental intrinsic value, multiply the yield factor with benchmark yield and then apply the market cap discount to the target dividend yield. As this is the target dividend yield without any top-up, I would then offset it with current income support or asset disposal. Below is the step:

__Base Information__

- Name -
**BAO****HUAT****REIT** - Top 3 Sectors -
**50% Retail, 50% Industrial** - Market Cap -
**S$ 4 billions** - Existing Income support -
**5%**of distribution - Existing Distribution from disposal -
**5%**of distribution - Forecast FY DPU -
**10 cents** - Yield Factor -
**0.8**

__Calculation__

- Market Cap Discount =
**0.5%** - Benchmark Yield = (50% x 4.75% + 50% x 6%) =
**6.25%** - Min. Yield = (50% x 4.25% + 50% x 6%) =
**5.375%** - Target Dividend Yield = 0.8 x 6.25% =
**5%**. As it is lower than min. yield of 5.375%, therefore I will take**5.375%**as target dividend yield, before applying the market cap discount. - Target Dividend Yield after Market Cap Discount = 5.375% - 0.5% =
**4.875%** - Target Dividend Yield after Market Cap Discount and Top-Up Offset = 4.875 / (100% - 5% - 5%) =
**5.417%** **Fundamental Intrinsic Value**= Forecast DPU / Target Dividend Yield = 10 cents / 5.417% =**S$ 1.84**(rounded down)

**3) Determine the Mean Reversion Price**

__Base Information__

- NAV per Unit -
**S$ 1.82** - Forecast FY DPU -
**10 cents**

__Calculation__

- Weighted Average P/NAV = 1.15 x 50% + 1.1 x 30% + 1.05 x 20% =
**1.115** **Price based on P/NAV Mean Reversion**= 1.115 x 1.82 =**S$ 2.02**(rounded down)- Weighted Average Dividend Yield = 4.75 x 50% + 5 x 30% + 5.25 x 20% =
**4.925%** **Price based on Dividend Yield Mean Reversion**= 10 cents / 4.925 =**S$ 2.03**(rounded down)

**4) Determine the Overvalue and Undervalue Price Range**

Now that we have fundamental intrinsic value @ **S$ 1.84**,** **P/NAV mean reversion price @ **S$ 2.02 **and** **dividend yield mean reversion price @ **S$ 2.03**. Next is to determine the prices for slightly overvalued/undervalued as well as overvalued/undervalued. Below are the benchmarks I am using:

For fundamental, I multiply the intrinsic value with the benchmark. For P/NAV, I take +1 SD as overvalued, +0.5 SD as slightly overvalued and vice versa. For dividend yield, I take -1 SD as overvalued, -0.5 SD as slightly overvalued and vice versa. The fair value would be the range in between slightly overvalued and slightly undervalued.

__Fundamental (rounded down for all)__

**Fundamental Intrinsic Value**=**S$ 1.84****Overvalued Price**= 1.84 x 1.1 =**S$ 2.02****Slightly Overvalued Price**= 1.84 x 1.05 =**S$ 1.93****Slightly Undervalued Price**= 1.84 x 0.95 =**S$ 1.74****Undervalued Price**= 1.84 x 0.9 =**S$ 1.65**

- NAV per Unit -
**S$ 1.82** **Price based on P/NAV Mean Reversion**=**S$ 2.02****Overvalued Price (+1 SD)**= (1.18 x 50% + 1.14 x 30% + 1.07 x 20%) x 1.82 =**S$ 2.08****Undervalued Price (-1 SD)**= (1.12 x 50% + 1.06 x 30% + 1.03 x 20%) x 1.82 =**S$****1.97****Slightly Overvalued Price (+ 0.5 SD)**= (+1 SD Price + Mean Reversion Price) / 2 =**S$ 2.05****Slightly Undervalued Price (-0.5 SD)**=(- SD Price + Mean Reversion Price) / 2 =**S$****2**

__Dividend Yield (rounded down for all)__

- Forecast FY DPU -
**10 cents** **Price based on Dividend Yield Mean Reversion**=**S$ 2.03****Overvalued Price (-1 SD)**= 10 cents / (4.5 x 50% + 4.7 x 30% + 5.15x 20%) =**S$****2.13****Undervalued Price (+1 SD)**= 10 cents / (5 x 50% + 5.3 x 30% + 5.35 x 20%) =**S$ 1.93****Slightly Overvalued Price (-0.5 SD)**= (-1 SD Price + Mean Reversion Price) / 2 =**S$ 2.08****Slightly Undervalued Price (+0.5 SD)**= (+1 SD Price + Mean Reversion Price) / 2 =**S$****1.98**

If your overvalue/undervalue benchmark is not an integer SD (whole number like ±1 SD or ±2 SD), then you would need to calculate the weighted average SD and multiply it with your benchmark instead of using the +1SD value from the table like the above example.

__Summary__

Let's put it into a table to have a clearer view.

Fundamental Intrinsic Value | Relative Valuation - P/NAV | Relative Valuation - Dividend Yield | |
---|---|---|---|

Overvalued | S$ 2.02 | S$ 2.08 | S$ 2.13 |

Slightly Overvalued | S$ 1.93 | S$ 2.05 | S$ 2.08 |

Fair Value | S$ 1.75 to S$ 1.92 | S$ 2.01 to S$ 2.04 | S$ 1.99 to S$ 2.07 |

Slightly Undervalued | S$ 1.74 | S$ 2.00 | S$ 1.98 |

Undervalued | S$ 1.65 | S$ 1.97 | S$ 1.93 |

**5) Determine the Buy/Hold/Sell Price Range **

__My Max. Buy Price Rule__

The lowest price of "slightly overvalued", which is **S$ 1.93 **for this case. Why not S$ 1.92 if you ask? This is because the figure S$ 1.93 is already rounded down in the calculation.

__My Min. Sell Price Rule__

The lowest price of the following:

i) Fundamental slightly overvalued AND relative overvalued

ii) Fundamental overvalued AND relative slightly overvalued

Let's do a calculation for both scenarios:

i) Fundamental slightly overvalued AND relative overvalued

- Fundamental slightly overvalued = S$ 1.93
- Relative overvalued = S$ 2.08
- To meet both requirements, price =
**S$ 2.08**

- Fundamental overvalued = S$ 2.02
- Relative slightly overvalued = S$ 2.05
- To meet both requirements, price =
**S$ 2.05**

**S$ 2.06**in this case.

__Summary__

**Buy **Range = **≤ S$ 1.93**

**Hold **Range = **S$ 1.94 to S$ 2.05**

**Sell **Range ≥ **S$ 2.06**

Optionally, we can further define a strong buy range and a strong sell range. I use the value below 0.95 x max. price as strong buy range and the value above 1.05 x min. sell price as strong sell range. After computation, the result would be as below:

**Strong Buy** Range **≤ S$ 1.83**

**Buy **Range = **S$ 1.84 to S$ 1.93**

**Hold** Range = **S$ 1.94 to S$ 2.05**

**Sell **Range = **S$ 2.06 to S$ 2.16**

**Strong Sell** Range **≥ S$ 2.17**

**S$ 2.00**for BAO HUAT REIT is within the

**hold**range.

**Conclusion**

These steps provide me a systematic way to make decisions instead of plucking figures from the sky. The end result could be a big difference with different criteria set though. Below is the infographic for my thought process flow, starting from the fundamental analysis:

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