Reviewed & Updated On: 26 Jun 24
When you invest in a Real Estate Investment Trust (REIT), it's crucial to examine the tenants' leases to understand the REIT's occupancy rate in the near term. One of the most significant risks in REIT investments is vacancy. If a property or parts of it stay vacant for too long, it will affect property income and shareholder distributions.
This is where the Weighted Average Lease Expiry (WALE) becomes a valuable tool.
WALE measures the remaining lease terms of all tenants in years, weighted by either the tenants' net lettable area (NLA) or their gross revenue income (GRI). NLA weights the lease terms by each tenant's physical space, while GRI weights them by each tenant's revenue.
Other terms, such as Weighted Average Lease Term (WALT) and Weighted Average Unexpired Lease Term (WAULT), are often used interchangeably with WALE.
Just like a doctor wouldn't rely on just one test to diagnose you, WALE shouldn't be the only factor you consider when picking a REIT. It has its limitations.
Let's look at an example. Say a REIT has three tenants:
Tenant 1: Leases a small area (10%) but has a short lease (expires in 3 years).
Tenant 2: Leases a big chunk of the space (70%) with a long lease term (expires in 7 years).
Tenant 3: Leases a medium-sized space (20%) with a moderate lease term (expires in 4 years).
The WALE would be calculated as:
(0.1 x 3) + (0.7 x 7) + (0.2 x 4) = 6 years
In this example, WALE tends to skew towards tenants occupying a larger REIT area.
So, why exactly should WALE matter to you as a REIT investor?
REITs with high WALE (typically above five years) tend to offer more stable income. A longer average lease expiry translates to a steady stream of rental income for the REIT, minimizing vacancy risks. That sounds pretty good, right?
Hold on a second. There's a flip side.
While a high WALE protects you from vacancy woes, it can also limit growth opportunities. Here's why: imagine the rental market is booming, and everyone wants to pay a higher rent. A REIT with a high WALE might not be able to capitalize on this right away because most tenants are locked into their current lease rates.
Consider it like this: REITs with high WALE often have reliable, long-term tenants like government agencies or big corporations. These tenants are fantastic because they rarely leave, but the downside is that rent increases are usually out of the question during their lease terms. This can limit the REIT's ability to grow its rental income internally.
Conversely, REITs with low WALE come with higher vacancy risks. Since leases expire more frequently, a property might be vacant while the REIT searches for a new tenant.
However, this risk can be offset by the potential for significant growth. With more frequent lease renewals, the REIT has the opportunity to negotiate higher rents, boosting its overall income. They can also take advantage of a hot rental market by quickly adjusting their rates.
Of course, there's a catch. More frequent tenant turnover often means higher costs for the REIT in terms of leasing fees, advertising, and legal paperwork.
The bottom line? WALE is a valuable tool to understand a REIT's tenant mix and lease expiry timeline. There's no magic WALE number that guarantees success. A low WALE can be a double-edged sword, just like a high WALE.
The key takeaway is to use WALE alongside other factors when analyzing a REIT. Look for a REIT with a healthy occupancy rate, a track record of growing its rental income, and a management team that can navigate the ever-changing real estate market. By considering the whole picture, you'll be well on your way to making informed investment decisions in the exciting world of REITs!
Comments