The Infatuation With REITs

Since the listing of CapitaMall Trust in July 2002, the number of REITs has really proliferated in Singapore. After a short span of a decade, there’s now almost 30 REITs listed on SGX and I am willing to bet that there’s more in the pipeline.

The huge amount of supply has been created largely to meet the desire and demand of the public “to invest in a professionally managed portfolio of real estate, through the purchase of a publicly-traded investment product.”*

But why are REITs so popular, especially with retail investors?  Here’s some of the reasons I have thought of.

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Appeal of landlord business

“The investment objective of REITs is to provide unit holders with dividend income, usually from rental income, and capital gains from the profitable sale of real estate assets.”*

The idea of being a landlord appeals to most Singaporeans. Conventional wisdom dictates that one has “made it” when he’s able to own a 2nd property. That’s when he can reap passive income in the form of rentals and participate in the property cycle, buying that 2nd property during a property bust and selling during a boom and repeating the cycle till he gets ridiculously rich.

In land-scarce Singapore, this train of thought has been backed up with statistics like the private property price index from 1975 to 2014. I guess it’s also probably safe to assume that 80% of the owners of multiple properties have made good money on their properties for the past few decades.

But with the government trying to curb exuberance in the residential property market by introducing the Total Debt Servicing Ratio (TDSR) of 60%, this dream is out of reach for many Singaporeans in their 30s and 40s.

But it’s ok because with REITs, investors can also take advantage of leverage. And instead of owning just one more property, he can even diversify and own multiple properties just by investing in a REIT. These investors are able to replicate the behaviour of a landlord by collecting the rentals in the form of dividends.

Flat STI Index for past 4 years

I like to use a period of 4 years here since that’s the time yours truly has been invested in the market. 🙂

And it makes for good comparison since the STI has appreciated little since mid November 2010. It was hovering at around the 3,200 mark and there’s only an increase of 100 points after 4 years. A $10,000 investment made then would have meant little capital gains, with an annualised appreciation of less than 1%. The total returns would still be less than 4% after including dividends.

If that investor had made an investment in one of the REITs that yielded 6%, assuming no capital gains or losses, he would have achieved a superior return. Not to mention that many REITs have enjoyed capital appreciation in the last 4 years. The price of First REIT (a stock that I hold), has increased from 70 cents in late 2010 to ~$1,20 today, an annualised gain of 14%.

Plenty of yield-hungry investors

Since REITs are required to distribute at least 90% of taxable income each year to enjoy tax exempt status by IRAS, the dividend yield is generally higher than most other stocks. Not to mention bonds. Most REITs offer a 3-4% spread above that of 10 Year SGS bonds.

And there’s a lot of yield-hungry investors out there.

With many more people pursuing financial independence, a straight-forward way of measuring progress and achieving this holy grail is illustrated through this equation:

Dividends > Expenses

There’s no need to practise complicated withdrawal ratios and selling off your stocks to fund the expenses when dividends would suffice.

And if one’s expenses is less than $12,000 a year, it would merely take $200,000 of investment in 6% yielding REITs to achieve financial independence. Instead of a much harder $400,000 in an STI ETF that yields 3%.

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And in case you’re wondering, I am actually pretty skeptical of using REITs as a primary tool in my investments at this point in time. What’s popular in the financial markets is generally more risky. This also probably explains why I use “infatuation” in the title instead of a more neutral word like “allure”.  😛

*The information is extracted from ====> http://www.moneysense.gov.sg/understanding-financial-products/investments/types-of-investments/real-estate-investment-trusts.aspx

 

17 Replies to “The Infatuation With REITs”

    1. Hi PIB,

      If you were vested during the 08/09 period, then it has been one good ride and you must be sitting on very good gains! =p

      I am a bit concerned regarding REITs as the yield for REITS is going down quite a fair bit. The question is, what is a fair spread of yield for investors to take on REITs as compared to bonds?

      For me, it needs to be at least 4% (margin of safety) for most types of REITs and with interest rates rising, bond yields should rise. But it remains to be seen if REITs can increase their rentals to maintain the spread.

  1. I am kind of interested in REITS nowadays too and pick-up quite a fair bit of fundamental knowledge… Mentally, it give me a sense that REITS is ‘safer” than Stocks 😉

    1. Hi Richard,

      To me, as an asset class, REITs can be just as risky as common stocks.

      Not trying to scare you but during a bear market (08/09), REITs prices plunged as much if not more than many stocks. Then, the issue was whether some of them could refinance their debts. This is an issue that won’t go away since all REITs have to be leveraged to remain attractive. Otherwise, their yields would drop to <5% and that would not make it palatable for most investors.

      Of course, some REITs are better than others. Besides better assets, good management is crucial to make it a good investment.

  2. Hi 15hww

    The reason why Reits get so popular in the past 5 years is because of the low interest rate environment we have in the economy which brings the yield spread much lower than what they should be at. That can be dangerous, if they are overvalued.

    I think the governance of Reits compared to 2008 is very different today. Their balance sheet and refinancing schedule is much more prudent and there are even association of Reits that will look after the corporate governance of all this. It still depends on how the management works towards giving better value to shareholders but I think overall they have stepped up their intensity not to repeat 2008 case.

    1. Hi B,

      The yield spread is a good indicator of how “safe” REITs as a class of instruments are.

      In 08/09, I remember reading that the spread rose to around 7%. That was probably the “safest” time to invest in them as a group.

      I am not familiar with the governance of REITs but the ultimate test will be the next bear market. The most well-managed probably won’t have to issue rights at a discount to raise cash.

  3. Hi 15HWW,

    Thanks for sharing your view. Perhaps as my nick implies, I am a keen investor in S-Reits.

    That said, I wouldn’t advise any newbie to jump into this security class without understanding the fundamentals and the additional risks involved.

    The obligation to pay out much of their income is a double edged sword. It means little buffer during a crisis when S-Reits are required to prop up their equity capital to avoid defaulting on their debt.

    High yields are there for a reason.

    1. Hi S-Reit System Investor,

      I believe there’s always a season for everything. So REITs can be a useful tool in the portfolio at the right price.

      It’s always good to walk in with your eyes open and understand not just the gains but the potential risks. I feel many beginners might have jumped in not knowing the risks. Like what you pointed out, a 90% distribution could come back haunting in “bad” times.

  4. Previously, 60% of my portfolio consisted of REITS. Over the last 3 years I’ve re-balanced this to 20%.

    When I started it was all about cash flow x3,

    But I am young, I’m still working, why do I focus so much on cash flow and give up capital gains.

    Regards,
    JW

    1. Hi JW,

      Wow, 60% is really quite a big overweight.

      When I first started, it was all about capital gains but most of the more recent transactions are more about dividends?

      Guess I also need to reflect why I am focusing so much on cash flow now. =p

  5. agree! Everyone find it so comfortable investing in reits as opposed to other types of securities. It tells me that expectations are gg to be high and sadly, the market oftens goes against investors’ wishes.

    1. Hi Alvin,

      More often than not, what’s popular is likely to be dangerous. And yes, I wrote this post as I find many of my friends illogically finding REITs a “comfortable” investment.

    1. Hi naro,

      Yup, the business model of REITs is easier for most to understand but the problem is that many do not ponder over the perpetual debt issue, possibility of future acquisition and what might possibly happen when some of the leases (especially Industrial REITs) are up.

    2. U hit the nail right on its head. Many people perceive reit to be much easily analysed. But is that the case? Can a few glance at simple ratio such as div yield, price to nav, gearing ratio determine true investment worthiness of a reit? So simple??

      Or are people thinking even if the reit is crappy, there is extra safety cushion in the form of div? Hence disregarding its risk and overlook fact that it is still traded like shares.

      Too simplistic thinking IMO.

      Another reason. Blind obsession with owning a piece of real estate property.

      1. Hi CSCCC,

        If only most people who added REITs performed a similar analysis to you when you added Frasers Centrepoint Trust. =)

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