6 Tips On Investing In Real Estate Investment Trusts (REITs)

Investment

6 Tips On Investing In Real Estate Investment Trusts (REITs)

REITs are a form of property investment without having to purchase any actual brick and mortar. These provide several advantages as well as drawbacks.

Published on 2 November 2016

A REIT (or S-REIT, when referring to Singapore REIT) is somewhat similar to a mutual fund. They are professionally managed assets. However, these assets are strictly properties – hotels, office spaces, shopping malls, etc.

When you purchase units in a REIT, you are entitled to a share of the rental income (and more rarely, sale) of its properties. These are paid out in dividends, much like a stock.

Most Real Estate Investment Trusts (REITs) specialize in one form of property. For example, hospitality REITs tend to focus on hotels and resorts, and commercial REITs focus mainly on malls or office spaces.

Each of these property types behave differently, and so do the REITs associated with them – hospitality REITs, for example, have a fairly predictable cycle of profit and loss (they perform better closer to holiday seasons, as this is when hotels and resorts are most in demand). Retail REITs are particularly sensitive to the relationship between their malls and the anchor tenants: if a mall’s main attraction is a theatre, then the closure of the theatre can mean a drastic fall in profits.

This entire mean that, before investing in a REIT, you should have a basic grasp of the property assets it manages, and how those assets behave. Much like a regular property investor, REITs require you to think like a landlord.

It is advisable to consult a wealth manager on the history and risks of a particular REIT before buying – do not rely solely on the managers of the REIT to answer such questions. While most are undoubtedly honest professionals, the REIT’s managers do have a vested interest in selling the REIT.

Why purchase S-REITs?

S-REITs are popular in Singapore because they are a less expensive and sometimes less risky in comparison to “regular” property investment. S-REITs also possess the same advantages as “regular” property investments: Singapore is a land scarce country with a high population density – the demand for real estate of any sort is practically constant.

(Note that the following information pertains to Singapore REITs (S-REITs). REITs in other countries are subject to different laws, and may have different practices.)

 

01.

Diversification

Consider the risks of investing in a single house, office, or hotel. Such an investment ties up a large amount of your money, and is susceptible to many risks:

What happens if the roads around the property are closed or redirected, making it more inaccessible? What would happen to rental yields if those road works are noisy and dusty, and take another three years? What happens if something undesirable – such as a landfill or view-blocking development – springs up next to your property? There are plenty of potential risks that could lower your rental income and property value.

When you invest in a REIT however, your money does not go into a single building. It is spread out among a number of different properties – even if something goes wrong with one, the others might be unaffected.

02.

High dividend yields

S-REITs are required to pay out 90% of their profits as dividends. This is different from equities, in which the board of directors mostly decides dividend payouts.

Most S-REITs provide annualised returns of between 5 – 9%. However, do check the historical performance of the S-REIT before buying. You can get a private banker to help you analyse the trust here, and determine if it fits your investment needs.

03.

Less capital intensive than buying property

Property investments require large amounts of capital (the bare minimum is usually 20% of your property value). In contrast, S-REITs are much cheaper and are easier to liquidate.

04.

Low gearing ratios

The gearing ratio of a S-REIT is a measure of highly leveraged it is (how much debt the trust has incurred in purchasing its assets). S-REITs are tightly regulated, and cannot have a gearing ratio that exceeds 35%*. As such, there is a low chance of S-REITs facing financial collapse.

(Some S-REITs have sought exemption from government policies and are allowed higher gearing ratios, all the way up to 60%. These should not be purchased without extensive consultation with your wealth manager; they are a significantly higher risk.)

05.

No property tax

When you buy S-REITs, you are investing in the trust that owns the property. You do not own the property, and hence there is nothing to tax.

06.

Restrictions on greenbelt development

Greenbelt development refers to the process of building property to rent out or sell.

In other countries, it is quite common for REITs to engage in this process. In Singapore however, there are tight restrictions on S-REITs – only 10% of their assets can go into greenbelt development. This discourages S-REITs from doubling as property developers – their role is mainly confined to buying and renting out buildings.

This is good for investors, as property development is a high-risk activity. If a REIT were allowed a free hand in it, they would essentially become property developers that borrow from you instead of the bank, and transfer all the risk to you.

What are the risks of REITs?

Because S-REITs pay out so much of their profits (90%), they tend to have little cash left in their reserves. One of the ways they overcome this is by paying only the interest on a property, and not amortising (paying down) the loan. Unsurprisingly, REITs are constantly refinancing their property loans, if for no reason than to chase the lowest interest rate.

If a REIT has not chosen or managed its assets well, there is a chance that banks will refuse to grant them a loan – this could leave them stuck with high interest rates (refinancing risk).

In addition, REITs cannot offload their liabilities (underperforming properties) as quickly as a mutual fund could unload bad stocks. They can’t sell a whole office building or mall in a few days! Sometimes, your REIT just has to suffer through a bad patch without being able to do much.

The other risks of REITs are quite similar to those faced by mutual funds: for example, you could suffer a capital loss if you sell when the value of your units fall, and debtors are paid before you in the event of bankruptcy.

An Overview on REITs

  • REITs are trusts that purchase and rent out property, and pay out dividends through the sale or rental of their property assets
  • S-REITs refer to Singapore REITs, which are subject to certain local regulations
  • S-REITs are required to pay out 90% of their profits as dividends
  • S-REITs are required have low amounts of debt (35% gearing ratio), which lowers their risk
  • REITs tend to specialise in different types of property (retail, commercial, hospitality, etc.) and you should have some understanding of these property types before investing

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