When you invest in REIT, you want to look at the tenants’ lease to understand REIT’s occupancy rate in the near term. One of the biggest risks in investing in REITs is vacancy risk. When a property, or parts of a property, is left vacant for too long, property income and distribution to shareholders will be affected.
This is where the metric Weighted Average Lease Expiry or WALE comes in handy as an assessment tool.
WALE measures all tenants’ remaining leases in years and is weighted by either:
The tenants’ net lettable area (NLA) against the total combined area of the other tenants.
The tenants’ gross revenue income (GRI) against the total combined income of the other tenants.
Other terms such as WALT (Weighted Average Lease Term) and WAULT (Weighted Average Unexpired Lease Term) are also used interchangeably.
Just like in stock analysis, there is no one financial ratio to determine whether the stock is a good or bad investment.
WALE is just one of the many metrics that we use to analyse REITs, and it has its limitations.
Consider an example of a REIT with three different tenants with differing lease terms:
Tenant 1: Occupies 10% of the net lettable area (lease expires in 3 years)
Tenant 2: Occupies 70% of the net lettable area (lease expires in 7 years)
Tenant 3: Occupies 20% of the net lettable area (lease expires in 4 years)
Therefore, the WALE is:
(0.1 x 3) + (0.7 x 7) + (0.2 x 4) = 6 years
From this example, WALE tends to skew towards the tenants that occupy a larger area in a REIT.
So why does WALE matter in REIT investing?
REITs with high WALE (usually >5 years) imply stronger income protection due to a longer lease expiry term. This means that the REIT has a steady* stream of rental income and faces the least risk of vacancy.
Steady* – Provided that the tenant does not go bankrupt throughout the lease duration and the tenant does not execute permissible break dates if given any.
While it can be a good determinant for investors, REITs with high WALE cannot capitalise on the higher rental during a market boom as its average lease expiry is longer.
This means that they are not able to negotiate rent hikes and therefore, pose a limitation in terms of internal growth.
For example, REITs with long WALE usually have the commitments of large tenants such as government agencies or multinational corporations. They have little to worry about vacancy risk, but larger tenants coupled with long leases would usually mean that the REIT will not be able to negotiate for rent hikes. This results in limited internal growth.
On the other hand, REITs with low WALE have a higher vacancy risk and are more susceptible to rental market movement as a shorter expiry term means frequent rental renewal.
However, they can generate a more robust internal growth through periodic rent hikes, resulting in better growth in property income. They are also able to capitalise on higher rentals during good times.
Note that REITs with low WALE may face higher costs in terms of leasing agent fees, advertising fees and legal fees.
In conclusion, an investor uses WALE to understand the REIT occupancy rate and its tenants’ lease expiry and is just one of the many metrics to look at when analysing REIT.
There is no ideal benchmark that determines an optimum WALE. A short WALE can be good or bad at the same time.
A REIT investor needs to take a comprehensive approach and consider other factors to ensure that the REIT occupancy rate will stay at high levels and is also growing its rental income.