The ABCs Of Reits

Foreword from ShareInvestor

This article “The ABCs Of Reits” by Lorna Tan was first published in The Straits Times on 01 Oct 2017 and is reproduced in this blog in its entirety.

A look at what is offered – potential long-term capital appreciation, regular income stream

There are many reasons why real estate investment trusts (Reits) continue to attract retail investors – not least because of their relatively high yields and stable dividends.

One number from United Overseas Bank tells the story: Singapore-Reits (S-Reits) have provided an annualised total return of 8.4 per cent over the past five years, nearly double the 4.4 per cent return of the benchmark Straits Times Index (STI).

The first S-Reit was listed in 2002 and there are now 32; alongside six stapled trusts listed on the Singapore Exchange (SGX)

With a combined market capitalisation of $80 billion, they provide opportunities for investors to diversify their exposure, says SGX market strategist Geoff Howie.

It is possible to build a well-diversified portfolio of real estate assets, spread across various sectors and, in some cases, geographies, through the underlying real estate assets S-Reits invest in.

Mr Jason Low, senior investment strategist at DBS Wealth Management, is optimistic about Asian dividend-yielding equities like S-Reits, believing they will benefit from a gradual rise in interest rates and long-term demographic trends.

Retirees typically gravitate towards Reits as an income source during their golden years.

What Are Reits And How Have They Performed?

Reits are like a hybrid between bonds and listed equities as they offer both potential long-term capital appreciation like equities, and a regular income stream like bonds.

Mr Bryan Lim, senior manager, Asian equities at Lion Global Investors, says it’s “the best of both worlds”.

Retail investors also find the concept of Reits simple: They are funds that raise capital to buy real estate assets such as malls, hotels and office buildings. Rental income from these properties then generates dividends for investors, says Ms Chung Shaw Bee, head of deposits and wealth management for Singapore and the region at UOB.

“Due to the lock-in nature of leases, this rental income tends to be stable. Besides, the value of the Reit is well-anchored by physical real estate, which has a good track record of long-term appreciation,” notes Mr Tan Teck Leng, senior fund manager at Phillip Capital Management.

He adds that the S-Reit market is generally well regarded by investors due to good corporate governance, the quality assets they hold and strong sponsors like Ascendas and Mapletree.

Calling Reits an “ideal investment for yield-seeking investors”, Mr Lim says that Bloomberg consensus estimates forecast the yield of this sector to be 6 per cent this year – the highest within Asia-Pacific’s larger Reit markets.

The yields of S-Reits are also higher than investments such as equities, Singapore government bonds and fixed deposits.

Do note that S-Reits are required to distribute as dividends at least 90 per cent of their annual rental income to unit holders, which is why they can offer investors a regular and predictable income stream. The frequency is at least twice yearly.

“Singapore is the second-largest Reit market in Asia (behind Japan) and is arguably the fastest-growing Reit market in the region,” says Mr Lim

“With the Government’s strong support for growth in this sector, in terms of favourable tax policies and robust regulatory framework, S-Reits have the potential to grow further, and investors should ride on this growth.”

As a reflection of Lion Capital Investors’ and Phillip Capital Management’s positive outlook on the Reitssector, both firms will be jointly announcing tomorrow the launch of Singapore’s first exchange-traded fund fully dedicated to S-Reits that will be listed on SGX.

Aside from its high and relatively stable yield, diversification is another benefit of adding Reits to your investment portfolio.

Studies have shown that adding them to a diversified portfolio increases returns and reduces risk as they have little correlation with the broad market, notes an expert panel from CFA Society Singapore (CFAS).

Eight Things To Look Out For When Investing In Reits

Like any investment product, there are benefits and risks involved.

1. Quality Of Dividend Yields

While it is tempting for investors to invest in Reits with the highest yields, they should closely examine the quality of the yield.

Mr Lim says: “We prefer Reits with predictable and transparent dividend yields that are solely generated from the underlying real estate assets.”

Nevertheless, UOB’s Ms Chung advises investors not to choose a Reit based on its yield only.

2. Gearing Level

This ratio looks at the Reit’s debt to its total property value. It is often referred to as “leverage” and measures a Reit’s vulnerability in a poor market.

Mr Lim notes that S-Reits have a regulated gearing limit of 45 per cent, while the sector’s gearing level is healthy at about 36 per cent.

3. Price To Net Asset Value (Nav)

A Reit’s NAV is associated with the value of its underlying real estate assets. Lion Global Investors believes that valuations on S-Reit assets are conservative compared with private real estate transactions.

For example, Jurong Point was sold in April at an estimated capitalisation rate of 4.2 per cent. In contrast, the capitalisation rate of comparable assets held by retail Reits in Singapore is at least 4.75 per cent. (Capitalisation rate shows the potential rate of return on the real estate investment).

This means that if investors were to invest in a S-Reit, they would be buying the underlying assets at a discount to the market rate. As such, it may be fair to determine that the S-Reits’ current NAV is understated, relative to the recent market transactions, adds Mr Lim.

4. Tenants’ Mix

Do not underestimate the importance of the Reit’s tenant mix, says Ms Chung. Let’s assume there is a Reit with a large proportion of tenants connected to the electronics industry.

“If there is a drop in electronic sales, the Reit will be adversely affected. A retail Reit needs to have a good mix of tenants to attract crowds and to encourage spending,” she notes.

A related factor is the occupancy rate. “This is essentially the amount of its total aggregate floor space that a Reit has leased out to tenants compared with the total that it owns across all of its properties,” says the CFAS experts.

“Ideally, a Reit should aim to be as close to 100 per cent (occupancy rate) as possible as this indicates that it is deriving the maximum possible revenue from its assets.”

5. Quality And Track Record Of Management

Given the intensive knowledge and expertise required to effectively run a real estate portfolio, it is important to gauge the quality of a Reit’s management team.

The market tends to value Reits with strong teams that have displayed a good track record of creating value for unitholders. For example, a good retail Reit management can choose to embark on initiatives to spruce up their older malls in order to improve tenant mix, which in turn creates more value for investors, says Mr Lim.

6. Diversify Your Risks

Financial experts advise that it is prudent for investors to diversify their risks by investing in a basket of S-Reits.

“As all real estate sub-sectors – retail, commercial, industrial, residential, hospitality and healthcare – move in cycles, it is difficult for investors to try to ‘time the market’ and stock pick,” says Mr Lim.

“A long-term approach to investing in a portfolio of diversified S-Reits would help investors to maximise the benefits of investing in this sector.”

7. Understand The History, Management, Portfolios And Financials Of Each Reit

Reit portfolios can be very different. SGX’s Mr Howie recommends that a good place to start building your knowledge base is StockFacts on the SGX website.

For instance, each of the three Reits listed on SGX last year – Manulife US Reit, Frasers Logistics & Industrial Trust and EC World Reit – invest in different real estate properties and different geographies.

Like an individual’s portfolio, Reit portfolios can also be in an acquisition mode as exemplified by Manulife US Reit. When ManuLife US Reit listed in May last year, it had three prime, freehold, quality office properties located in Los Angeles, Irvine (in California), and Atlanta.

The Reit has since acquired Plaza in Secaucus, New Jersey, funded by a placement in June, then 10 Exchange Place in New Jersey through a rights issue last month.

From its initial offer price, Manulife US Reit has returned an equivalent total return of 27 per cent assuming dividends were re-invested. It maintains an indicative distribution yield of 7.3 per cent, adds Mr Howie.

8. Rising Interest Rates

Mr Howie says that interest rate expectations have affected the performance of the Reit sector in recent years.

The sector has experienced some downturns, particularly in the second half of 2015. This coincided with expectations of an interest rate hike in the United States at the end of 2015, which did occur.

Markets also had expectations of multiple interest rates hikes last year, which did not happen. There was just the one hike at the end of last year.

“Hence 2016 saw the Reit sector recover those losses of the second half of 2015,” notes Mr Howe.

“In the 2017 year to date, the Reit sector has benefited from the same broad growth theme that contributed to strength in the real estate management and development stocks, in addition to the banks.”

Mr Lim adds that S-Reits have diversified their debt profile to include other instruments, such as perpetual debt and retail bonds, and actively managed their debt maturities. All this helps them better navigate times of rising interest rates.

Phillip Capital’s Mr Tan says that with an overall benign economic environment – which led to rate hikes starting in the first place – rents are likely to be negotiated higher when leases expire and, in turn, capital values of properties will also rise.