REITs As Another Investment Option

Foreword from ShareInvestor

This article “Reits As Another Investment Option” by Teh Shi Ning was first published in The Business Times on 08 Aug 2011 and is reproduced in this blog in its entirety.

Young investors with limited capital can invest in property through these hybrid instruments, reports TEH SHI NING

WITH one of the highest home ownership rates in the world, Singapore’s preoccupation with property is well-known. Beyond the residential sector however, land-scarce Singapore’s non-residential property segments – offices, shops, warehouses, factories, hospitality and healthcare real estate may pique investor interest too.

For the average young investor, with limited savings, but who perhaps already has a brokerage account and holds stocks, one accessible means of getting exposure to real estate, would be via real estate investment trusts (Reits).

“Young investors, who are constrained in capital, and yet would like to invest in real estate, could consider Reits as an alternative investment option,” says Deng Yongheng, director of the Institute of Real Estate Studies (IRES), NUS, and finance professor at the NUS Business School.

He describes Reits as “hybrid instruments that combine the features of real estate, stocks and bonds”.

Reits are essentially collective investment schemes, in which individuals invest by buying units – which are much like shares of a common stock.

Typically, a Reit raises money from unit holders through an initial public offering, which is then used by the company to purchase real estate assets such as shopping malls, offices, hotels, service apartments and so on.

Revenues from these assets, mainly rental income, are then distributed at regular intervals to unit-holders. In that sense, the investment goals a Reit meets are similar to that of stocks – current income distribution with the potential for long-term appreciation.

Benefits And Risks

Reits can be attractive because they involve low transaction costs, and allow investors to gain from real estate asset price appreciation, without owning and managing actual property. They provide liquidity, as investors can trade in small units without having to fork out huge sums upfront, unlike in property investments.

The flip side of course, is that investors are exposed to the liquidity risks and stock market volatility of investing in public-listed vehicles. Prof Deng points out that Reits are subject to property market demand-supply dynamics via their portfolios on one hand, while their prices are influenced by stock market trading activities and sentiment on the other.

Diversification is another benefit, as Reits typically have low correlation with other asset classes, such as equity and bonds, as well as broad market portfolios, says Prof Deng.

The “bond-like feature” really stems from dividends, typically paid out quarterly, he adds. It is mandatory for Reits to distribute at least 90 per cent of their net earnings back to investors, as dividends.

Professional management also has the advantage of greater transparency and accountability. But that too bears certain risks, if an external management structure creates conflict of interest between unitholders who bear the risks and the Reit managers who manage the risk, says Prof Deng.

Questions To Ask

When picking which Reits to buy, you may wish to ask the following questions:

  • What does the REIT invest in?

It helps to think through the factors influencing the performance of the underlying real estate sector in which each Reits’ assets lie. For office or commercial Reits, strong rental growth and a healthy occupancy rate in those markets would translate into higher rental income. Greater demand for healthcare services ought to impact Reits specialising in healthcare properties positively.

And factors driving the retail sector, such as stronger tourist arrivals perhaps, could boost Reits with retail mall assets, says IRES deputy director Sing Tien Foo. It is also worth understanding the quality of individual properties – such as the occupancy rates and tenant mix of a shopping mall or office building.

Reits with regional real estate strategies and assets in different countries may be suitable for investors looking for the means to also ride on strong growth in emerging and regional markets. But Associate Professor Sing also cautions that “geographically diversified Reits are, however, more difficult to analyse and less liquid because investors may have to incur higher information costs when evaluating the portfolios of assets in different markets”, for example in evaluating their political and regulatory risks.

  • What is a REIT’s structure?

Reits in Singapore are managed by external advisers, or asset managers. Assoc Prof Sing says: “The performance of Reit stock prices are closely linked with the reputation and experience of external asset managers. Reit managers that have strong track records could create shareholders’ value by pursuing yield accretive asset growth strategies and observing prudent borrowing practices.”

Reits are structured as trusts, which means its assets are held by an independent trustee on behalf of the unitholders. The Reit’s real estate properties are managed by a property manager, and the Reit itself is managed by a trust manager. These parties all receive fees for their services.

Hence, annual managers’ fees, property managers’ fees, trustees’ fees and other expenses, are deducted from the cash yields before distributions are made. Those with overseas properties may be subject to taxation there too.

Other things to find out would include what the Reit’s gearing and debt maturity is, and whether there are any other unique features that could add to its risks.

  • What is the dividend distribution policy?

The expected frequency and timing of dividend payments and the adjustments made to income before the distributable income is determined are worth finding out before investing.

Also, there may be circumstances under which a Reit will not pay dividends, such as an operating loss, a downward revaluation of properties or insufficient cashflow.

The first Reit was listed on the Singapore Exchange in 2002; there are now 22 Reits. Assoc Prof Sing notes that comparing quarterly returns on other asset classes, such as stocks, bonds and physical residential property, Singapore Reits’ returns have fluctuated more widely than other asset classes.

Looking at a sampling of time periods, (see table) Assoc Prof Sing observed that the Standard & Poor’s (S&P) Singaporean Reit Index outperformed other quarterly indicators such as the Straits Times Index, URA’s private residential property price index and 10-year government bond yields in terms of year-on-year returns. But, they also showed higher volatility between Q3 2004 and Q2 this year.

Of course, history is no guarantee of what is to come and Ang Ser-Keng, finance lecturer at SMU’s Lee Kong Chian School of Business, points out that performance is not uniform among the Reits.

And, as with all other investments, it is ultimately for the investor to compare the Reit with the other options and decide if its structure and risk profile suits his or her risk appetite and investment time horizon.