Owning a property is most people’s lifetime dream. However, you may spend most of your savings on a substantial initial amount needed for a downpayment, not to mention subsequent mortgage payments. Besides, you also have to pay running costs like maintenance, management fees, house decorations, utility bills. Before you own a house, you may consider another alternative – Real Estate Investment Trusts(REITs).
What is a Real Estate Investment Trust(REIT), and How Does It Work?
Regulated by the Monetary Authority of Singapore(MAS), A REIT is an investment trust holding, operating, and financing real estate. The Real Estate Investment Trust aims to provide steady dividend income streams to unitholders with modest share appreciation. The trust does not pay tax if the trustee pays 90% of “taxable income” out to unitholders and enjoys “tax transparency” treatment of 10% withholding tax on the remaining income.
- A REIT listed in the Singapore stock exchange must have a 25% capital held by public unitholders or have units held by 500 public shareholders.
- The real estate investment trust’s activities are subject to the Code on Collective Investment Schemes with the Property Fund Guidelines issued by the MAS.
- At least 75% of its portfolio should be income-producing assets.
- A REIT should not hold more than 5% of a portfolio on an issuer’s securities or manager’s funds.
- Singapore investors are exempt from all REIT distributions.
Types of REITs
REITs have broad investment scopes based on property types and their tools used in investing. They differ in risks and returns.
- Equity REITs: They own and operate property businesses. That means they maintain, make the upkeep, and manage the property businesses. The equity REITs are the landlords letting out the properties for rental income.
- Mortgage REITs: Instead of buying and running property businesses, REITs buy the mortgage from banks or alternative financial lending firms and collect income from the mortgage payments. The complexity of dealing with mortgagees rather than property management makes income collection more challenging than direct running business. Therefore, mortgage REITs pay higher dividends than equity REITs.
- Hybrid REITs: It is a combination of equity and mortgage REITs. The advantage is an increase in income and security owing to diversification.
Kinds of REIT Businesses
- Healthcare REITs: The REITs focus on running hospitals, medical centers, nursing facilities, and retirement homes businesses. Medical businesses are popular owing to the aging population and skyrocketing medical expenses. However, investors should carefully review business soundness and their financial strengths. Besides, the industry is changing its practices as the regulatory environment evolves. The failure probability is high if newcomers cannot adapt to industry shifts.
- Commercial or Industrial REITs: REITs buy commercial or industrial properties and lease to businesses for rental income. They make more stable profits and share appreciation if corporations have long-term leases with landlords. Investors earn higher dividends if the region a REIT invests in improves the economy. In the same way, losses may occur as the economy deteriorates.
- Residential REITs: Apartments are residential REITs’ primary targets. They buy up or construct the buildings and provide housing services like housekeeping, cleaning, laundry. Rental is the primary income source. Like commercial and industrial REITs, the economy plays an essential part in a residential REIT’s business. The business may flourish owing to high demand from a booming economy. The reverse is true from a sliding business environment.
- Retail REITs: Shopping malls or a hybrid property investment with offices and shopping centers are favorites of retail REITs. Like other REITs, a retail REIT may face fewer traffic issues and defaults by tenants. Besides, the recent online shopping trend may affect customers’ inclination to shop in person. Finally, retailing is also an economy-sensitive industry. Before investing, investors should study a retail REIT’s financial strength and business history.
- Data Center REITs: The portfolio holds and manages properties used by data centers for storing data and servers. The REITs are popular due to vast demand from companies switching from traditional information storage to cloud and digital computing.
3 types of REITs(equity, mortgage, and hybrid) may invest in 4 kinds of businesses, diversify their portfolios, and increase profits.
How to assess REITs
The following serve indicators of a sound REIT if you consider investing:
- Past performance: A history of the capability of earning profits and financial strength is a vital indicator you shouldn’t ignore. A REIT with a record of regular and stable earnings creates a reliable income for unitholders. Likewise, a financially strong REIT provides a base for further solid expansion and reduces shareholders’ dilution risk, leading to probable price appreciation.
- Management turnover: Like any business, a REIT with frequent personnel changes, particularly the management, is not likely to perform for shareholders. An experienced workforce and outstanding leadership with a robust culture play a critical part in a company’s success. It isn’t hard to think of what impact on the company and its profits repeated personnel changes will bring.
- Funds from operations(FFO): An FFO is a cash a REIT generates from operations during a period. It includes essential non-cash components, e.g., depreciation and amortization expenses and net gains or losses from the asset sale. They are more reflective of the income a REIT generates from the business. The more FFO is, the more profitable a REIT is.
- Portfolio components: Assets form pillars of a portfolio. Most of the time, the quality and number of assets determine the success or failure of a REIT. A REIT with a portfolio of rental defaults and unstable or late rental payments cannot maintain a healthy income source for its shareholders.
Likewise, a REIT with a few assets may risk losing portfolio income due to the possible loss of tenants from its properties.
- Expense ratios: Industry expense ratios are around 0.5% to 0.9%. High expenses may hurt a REIT’s return as the fund has less capital deployed to expand and develop projects. What it can distribute to shareholders becomes less.
Like other investments, you should do thorough research and calculations on REITs.
If you are busy with others and worried about making wrong decisions, two alternatives may be the best alternatives to REIT investments: 1. Talk to an expert on the field! He may give you the best advice. 2. Invest in a REIT ETF! The investment tool invests in ETFs in the market and spares you any effort on research.
Pros and Cons
- High-income streams: With its portfolio-nature and tax purposes, a REIT distributes 90% of a “taxable income” to shareholders and provides stable and high-yield dividends to passive-income investors. Besides, REIT investors are also exempt from income tax and, that means, they can use each cent of a dividend distributed by a real estate investment trust.
- Diversification: If you have stocks and bonds in your portfolio, including REITs can reduce the risks caused by fluctuating stock prices and stabilize a portfolio’s value during the market depression. The steady income stream provided by the real estate investment trusts also enhances your portfolio’s return.
- A liquid investment: Unlike real properties, you can trace and track REITs in a stock exchange. Like other stocks, you may invest in a REIT as you invest in a stock. Besides, investing in REITs is one simple and convenient option, where you can take part in property investments with a small sum of money.
- Risks from rising interest rates: Same as real properties investments, REIT investing is sensitive to interest rate policy. Most REITs use financing to develop property projects and therefore are vulnerable to rising interest rates. Some REITs have to sell some of the portfolio components to reduce interest payments, leading to loss of income and future development opportunities.
- Risks from economy cycles: REITs perform better because they can increase the rentals and develop more projects during a booming economy. As with other businesses, REITs may cut costs and halt projects in progress to keep companies in an optimal situation. The optimal condition refers to keeping the company in a sound business and financial position and distributing dividends to shareholders.
- Passive investment style: REITs, like bonds, are income-producing assets and distribute most of their earnings to unitholders. Active and aggressive investors may find less appealing than other industries as high-growth sectors like technology; healthcare. It may not be the best choice for investors looking to outperform the market.
How to start investing in REITs
As stated earlier, it is easier investing in REITs than real property because the sum for investment is small and a REIT liquid. You can see most REITs listed on the Singapore stock exchange. All you have to do is open an account with a brokerage or a bank and start trading with it.
Besides, you can buy a unit trust or exchange-traded fund(ETF) investing in real estate investment trusts instead. The benefit is you have a well-diversified REIT portfolio by buying into a unit trust or ETF.
What are the risks?
- Capital growth risk: REITs have difficulty in developing new projects as they distribute most income to unitholders. They can only turn to bond or equity financing for future business expansion. As a result, external financing may further dampen the stock prices.
- Inflation risk: Due to the high debt ratio and limited capital growth limiting the price upsides, most REITs cannot outperform inflation. The value may shrink over a high inflation period.
What are the essential indicators in assessing REITs?
If you’re planning to go straight to REITs, you shouldn’t ignore 4 indicators. You may determine a REIT’s soundness based on the 4 gouges.
The first is the dividend yield. Besides the yield benchmark, you should review the yield history if it is consistent and on track to payments. Fluctuating dividend payment history may reveal the REIT’s long-term dividend-payment capability. Irregular payment records may indicate a REIT’s operating and financial ability in business.
The second is a property yield. It is the income generated by a property held to the market value and reflects its capacity to produce the maximum income. Therefore, the higher the property yield, the more valuable the property is.
Price-to-book (P/B) Ratio
Third, another crucial ratio is the price-to-book(P/B) ratio. The indicator reveals a market view on a REIT’s value. An appropriate PB is 1. When it is under 1, it means the ratio is undervalued and may indicate an investment opportunity. Nevertheless, it may reflect a REIT’s other downsides. When it is over 1, the price is higher than the proper value, and you should consider if you will overpay the price.
The final metric is a gearing ratio. It is the total debt over total property and reflects the leverage a REIT uses to invest in its property. You can find it logical saying the higher the gearing ratio, the more probable it may default. The reverse is a better investment. The Singapore Government has set a legal gearing ratio of 45% maximum.
Should I buy REITs while I have held other investments like stocks?
A quality REIT is an excellent investment to portfolio diversification even though you are an aggressive investor. You may reduce your overall risk by including them in your portfolio because of their pricing stability and consistency. More than that, it can increase the portfolio income, particularly during a market downturn.
A REIT or a REIT unit trust or ETF, which is better?
A REIT is an investment portfolio you hold a part of. If a real estate investment trust has one hundred units, you buy 2 units and become a 2% owner of the unit trust. You are entitled to 2% benefits from the trust.
If you want to reduce the costs, a REIT is your option. But you should spend time reviewing the targets you’re interested in before putting money in one. The risk is you may make a wrong decision. You can talk to a financial advisor beforehand.
If you invest in a REIT unit trust or ETF, you take a proportional part of a fund holding over one REIT in its portfolio. In addition, an ETF tracks by investing in constituents of a REIT index.
The advantage of investing in a unit trust or ETF is that the fund manager will do the research and investing job. Yet you pay additional fees like management fees. Of these, an ETF charges lower fees than a unit trust because it is an index-tracking investment. Read on the differences between ETF vs unit trust.
You ought to consider your time constraints in choosing an appropriate vehicle, except for costs, suitable for your investing style.
How many REITs are there in Singapore? What is the total market value?
As of May 31, 2019, Singapore has 44 REITs available in the local market. The total market capitalization of REITs, unit trusts, and ETF has exceeded S$100billion. The industry has seen a 22% compound annual growth over the last years since 2009. The average dividend yield for the industry is 6.5% per year.
What are the top 10 REITs in market capitalization in Singapore?
The top ten REITs in Singapore are as follows in market capitalization:
1. Ascendas Real Estate Investment Trust(A17U): S$11,586million.
2. CapitaLand International Commercial Trust(C38U): S$12,820million.
3. MapleTree Commercial Trust(N21U): S$5,980million.
4. MapleTree Logistic Trust(M44U): S$8,075million.
5. Suntec REIT(T82U): S4,358million.
6. MapleTree North Asia Commercial Trust(RW0U): S$3,810million.
7. MapleTree Industrial Trust(ME8U): S$6,647million.
8. Keppel DC REIT(AJBU): S$3,671million.
9. Ascott Trust(HMN): S$3,342million.
10. Frasers Commercial Trust(TQ5): S$4,335million.
What are the largest REIT sectors?
The largest sector REITs are commercial and industrial REITs. The two sectors take up more than 40% of the total REIT market and are geographically diversified as more than 80% have businesses overseas.
What are the top sectors in performance for 2021?
The top sector performers for 2021 are healthcare, office, and retail REITs. The healthcare sector has recorded around 35% growth; the office sector has seen about 10%, and the retail has exceeded 9% growth.
Passive investors can invest in REITs for stable income streams, and active investors can diversify portfolio risks and enhance portfolio returns during market downturns. You should research and choose one or more REITs suitable for personal investment criteria based on 4 indicators. Instead, you may invest in REIT unit trusts or ETFs to save your time and effort.
- REITs offer steady income streams.
- Active investors use REITs to diversify portfolio risks and enhance returns.
- 4 indicators are the golden rule for examining REITS: Dividend yield; Property yield; Price-to-Book ratio, Gearing ratio.
- Choose a direct REIT if you spend time researching and cut costs. Otherwise, choose a REIT unit trust or ETF if you require more diversification and time-saving.
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