Owning properties and collecting rental income, while simultaneously enjoying property appreciation, seems like a dream for many. However, the barriers to entry for owning properties from different parts of the world, or even Singapore, can be extremely high. To a great extent, this is attributable to the huge amount of capital required.
Thankfully, there are ways to gain investment exposure to properties across geographies or within Singapore, without risking too much capital. One such way is to invest in REITs.
What are REITs?
REITs, or Real Estate Investment Trusts, are real estate companies whose main focus is to manage investment properties under their holdings. These include elements such as, but are not limited to: property management, asset management, financing, handling of legal and tax matters. REITs work in a similar manner as mutual funds. A pool of capital is collected from investors to invest in an asset or portfolio of assets. In the case of REITs, such assets can either be investment properties, or in less common cases, real estate mortgages. Investors in REITs are not responsible for managing the properties. Unless they are major shareholders, they are unable to influence the management and decision making of the REIT. Investors are usually paid dividends through the rental income collected by the REIT. REITs are usually publicly traded. However, it is worth noting that there are private REITs found in countries such as the United States of America (USA) and Japan.
You can participate in a REIT investment just like how you invest in a stock: Get a broker to purchase for you, or you can purchase it through a custodian or Central Depository Account (CDP) through the stock exchange. One of the defining features of a REIT is the tax benefits. In the case of Singapore, rental income for REITs is not taxable at the corporate level, provided the REITs distribute at least 90% of the net income to shareholders.
Key features and benefits of investing in S-REITs (Singapore - Real Estate Investment Trusts)
S-REITs are exempted from being taxed at the corporate level, with the condition that 90% of the taxable income are issued to shareholders within 3 months before financial year-end. The tax exemption helps to avoid double taxation (at both trust and individual levels), allowing unit holders to enjoy better DPU (Distribution Per Unit).
Low Leverage Risk
Because REITs are designed to give small retail investors access to real estate investment, regulators have an obligation to protect these investors. To manage leverage risk, S-REITs are bound by conservative leverage limits (Leverage limit capped at 50%, last updated 16 April 2020). This ensures adequate debt service coverage and prevents over-leveraging, reducing the risk of a REIT breaching its debt covenants.
High Level of Transparency
REITs listed on regulated stock exchanges such as SGX (Singapore Stock Exchange) are subject to high disclosure requirements. Investors are able to easily access and scrutinise updated financial information, material business developments and risks of the listed REITs. Markets with high REIT penetration tend to be highly transparent because of the reporting obligations.
Ease of Liquidity
Compared to physical real estate, the time taken and effort to buy and sell a REIT is so much faster and easier as REITs are publicly traded like stocks. In stark contrast, buying and selling physical real estate requires going through a tedious process of negotiating price and getting a mortgage from banks for buyers.
Barrier to entry for REITs investments is low compared to physical real estate as you are owning a small portion of a REIT portfolio. You can adjust the amount of capital you would like to invest in depending on your financial situation. REITs provide an affordable alternative to invest in real estate. As such, you don’t have to worry about high upfront payment and over-leveraging, like you would when purchasing a physical real estate.
Types of REITs asset class
Globally, there are 3 main types of asset class/securities which REITs manage.
- Equity REITs: These types are the ones which we are more familiar with. Equity REITs consist of income generating types of property, such as hotels, office space or residential housing. All REITs in Singapore are equity REITs. We would be exploring more on equity REITs (more specifically S-REITs) at a later section.
- Mortgage REITs: As the name suggests, this type of REITs holds mortgages in their portfolio. Mortgage REITs (M-REITs) profit from interest collected through mortgage loans. Although there are less management fees involved, M-REITs do not hold any tangible assets. They are highly sensitive to interest rate fluctuations and credit risk. (There are no mortgage REITs found in Singapore).
- Hybrid REITs: This class of REITs combines both investment strategies of Equity REITs and Mortgage REITs. The income is generated through rents and also interest collected from mortgage repayments.
Types of S-REITs
Equity REITs invest across a wide range of real estate sectors, from healthcare, retail, office, industrial, logistics, hospitality properties to niche segments like data centres. Typically, a REIT will choose to specialise their investments in a particular niche/ sector of the real estate market. Below are a few examples of the different types of equity REITS available in Singapore.
Commercial/ Office REITs
Office REITs own and manage office spaces. They generate income through renting office spaces to different companies that require working spaces for their employees. Stabilised office assets with strong tenant profiles are the core focus of office REITs investment. When investing in office REITS, you have to do your due diligence on the macroeconomic indicators in the location of the real estate owned by the commercial industry. A wide range of factors such as unemployment rate, rental vacancy and upcoming competitive supply could affect the revenue generated from the REITS greatly.
Commercial/ Office REITS in Singapore:
- OUE Commercial REIT
- Keppel Pacific Oak US REIT
- Manulife US REIT
- IREIT Global
- Suntec REIT
- CapitaLand Commercial Trust
- Keppel REIT
These REITS typically own light industrial, business park or logistics assets in industrial zones. These real estate include warehouses, factories and distribution centers. With the exception of multi-tenanted light industrial assets, industrial properties are a niche type of real estate investment, and it is crucial to get long term tenants. A vacant space may take a long time to find a matching tenant, as customisation and re-structuring of the industrial real estate is often needed to fit the needs of the new tenant. Land tenure is another important factor for REITs managers to consider; Most industrial zoned land comes with tenures that are shorter relative to other land zonings.
Industrial REITs in Singapore:
- Soilbuild Business Space REIT
- ARA Logos Logistics Trust (ALog) traded as Cache Logistics Trust until April 2020
- ESR REIT
- EC World REIT
- Sabana Shari’ah Compliant REIT
- AIMS APAC REIT
- Frasers Logistics & Commercial Trust
- Ascendas REIT
- Mapletree Industrial Trust
- Mapletree Logistics Trust
- Keppel DC REIT
Retail REITs usually own shopping malls, outlets and big box retailers. Income is generated from retail tenants paying rents to run their businesses.
Retail REITs are relatively more challenging to evaluate for several reasons. Unlike the office or industrial sectors where rents tend to be fixed, retail rents can be a percentage of their turnover, or a combination of fixed base rent plus turnover component, resulting in potentially higher volatility. The heterogeneous nature of retail real estate makes comparables analysis more difficult. Given the competition from e-commerce and changing consumer behaviour, investors need to get a handle on the vulnerability of assets in the REITs’ portfolios as well as the REIT managers’ experimental strategies to reposition their assets.
Retail REITs in Singapore:
- Lippo Malls Indonesia Retail Trust
- Starhill Global REIT
- Mapletree Commercial Trust
- Sasseur REIT
- SPH REIT
- CapitalMall Trust
- BHG Retail REIT
- Frasers Centrepoint Trust
Hotels and serviced apartments are the staple of hospitality REITs listed in Singapore. Unlike office, industrial and retail REITs, hospitality REITs go beyond just a pure real estate play. “Hotels are brands not bricks” - hotels are businesses which require extensive management. They should therefore not be seen as just rental units. Coupled with the physical asset portfolio and the macro environment, investors need to evaluate the strength of the hotel or serviced residence operator when investing in hospitality REITs. The hospitality sector is also susceptible to seasonal factors, giving rise to certain volatility in underlying rental collections. To address this, REIT managers tend to manage distributions in ways to help smoothen out dividend payments. Like the retail sector, the hospitality sector faces threats from industry disruption. In this case, the threat is brought about by the advent of players competing within the short-stay space such as Airbnb.
Hospitality REITs in Singapore:
- Frasers Hospitality Trust
- CDL Hospitality Trusts
- Far East Hospitality
- Ascott Residence Trust
- ARA US Hospitality Trust
Core investments are medical facilities that encompass a vast array of infrastructures, such nursing homes, hospitals and medical centers. By and large, healthcare is an investment theme that caters to fairly inelastic demand and is well-supported by long-term structural demographic tailwinds. But similar to hospitality, healthcare is also a business and investors need to evaluate the strength of the healthcare operator. Moreover, it is imperative to take note that the healthcare system and policy changes in a country can exert significant influence on the performance of healthcare REITs. For investors into healthcare REITs, another area which they should pay close attention to is the potential disruption from technological changes. Increasingly, there are apps looking to serve certain outpatient needs where people seeking medical advice can do so entirely online.
Hospitality REITs in Singapore:
General considerations when investing in REITs (Key metrics)
Understanding the market condition of the real estate industry is important before investing in REITs. The following indicators are used to assess the market
- Occupancy: The core income from equity REITs is mainly through rental units and high occupancy. Naturally, rental fees means more revenue collected. To analyse the market occupancy of the properties owned by the REITs, you can visit Knight Frank, Savills and CBRE for more information on occupancy rates in different cities.
- Net absorption: Net absorption rates indicate the volume of properties being leased in a particular time frame, and this is an important indicator of tenant demand. Sustained healthy net absorption in markets with moderate upcoming supply translates into increasing occupancy rates and upward pressure on rents.
- Upcoming supply pipeline: Real estate is unique because there is considerable lead time for the supply side to respond. In any given market, the upcoming supply is fairly visible but some investors do not take advantage of this vital piece of information when evaluating markets Ultimately, rents and by extension, distribution per unit to REIT shareholders are derived from the interaction between net absorption and supply.
- Price trends / Rental trends: Empirically, property markets move in cycles and sharp dislocations are relatively rare occurrences. When considering investments into REITs, it is important that investors have a handle of where the portfolio assets sit within their respective property cycles. Prices tend to be forward looking and usually move in advance of rents. It is therefore fairly common for prices to rise even while rents are falling, but at a slowing pace.
- Tenant mix and profile: The strength of tenant covenants is central to the security of rental payments. Investors should scrutinise the tenant mix and profile to be comfortable that risks are sufficiently diversified, anchor tenants are not in vulnerable positions and have a high probability of honouring their rental contracts.
- WALE (Weighted Average Lease Expiry) Occupancy: WALE is a metric/model used to estimate the risk of a real estate property being vacated. The WALE metric is calculated by taking the average of lease expiry of the property. For example:
Tenant A: Holds 50% of real estate area (5 years to ease expiry)
Tenant B: Holds 30% of real estate area (3 years to ease expiry)
Tenant C: Holds 20% of real estate area (7 years to ease expiry)
WALE is computed as: 0.5 x 5 + 0.3 x 3 + 0.2*7 = 4.8 year
Therefore the property occupancy sustainability is about 4.8 years.
A higher WALE value is a more secure investment as revenue is secured through the lease.
- Sponsor's background: Most REITs are backed by a sponsor whose main role is to support the REITS through supplying property or credit. Sponsors can be seen as major shareholders of the REIT. Having a strong sponsor will allow the REIT to have a strong line of credit through banks (banks are more willing to loan REIT if sponsor is strong) and also through the sponsor. This is extremely important especially during times of crises.
REITs Risk factors
REITs are usually seen as a safer investment as compared to other asset classes. However, there are risks involved in such an investment.
- Market risk: Publicly-traded REITs are exposed to the vagaries of stock market volatilities. The performance of REIT shares have closely tracked overall equity market performance, resulting in high positive correlations (coefficient as high as 0.86 during early 2011) and undermining their diversification value. The inherent inflation hedging virtue of real estate investment is also impaired when REIT share prices are affected by such a wide myriad of factors.
- Dilution risk: Because REITs are mandated to pass through 90% of cash flow, they have little to no retained earnings to fuel future growth. Whenever they want to make an acquisition, they need to raise fresh capital and unitholders face dilution risk if they do not subscribe to the new units. The Dilution effect puts some limit on REIT share price appreciation (investors may not fully benefit from underlying capital appreciation of the assets) because the enlarged rental income from new acquisitions need to feed more issued shares.
- Misalignment of incentives: Misaligned incentives between shareholders and REIT manager, and Sponsor. Part of the manager’s compensation is usually tied to the size of the portfolio or AUM (Asset under Management). This has led to managers veering off initial strategies just to enlarge the portfolio. For instance, Saizen REIT (now delisted from SGX), Saizen IPOed in 2007 as the first Japanese residential REIT listed on SGX. Saizen started investing in properties outside of Japan in hopes of expanding their real estate assets, which is a clear conflict of interest with investors who wanted a pure exposure/investment in Japanese residential property.As for Sponsor, some sponsors just make use of the REITs to monetize/divest assets, sometimes to the detriment of less well-informed/researched investors.
- Rise of market disruptors: With the rise of market disruptors from technological companies like Amazon, Ebay, Alibaba and Airbnb, this increasing trend has caused a significant market loss on both the retail and hospitality industry. The continuous advancement in technology will likely change many traditional businesses. It is therefore vital to keep up with technological and market trends so that you will avoid REITs which are affected by these disruptors.
Alternative investment option in Real Estate
Notwithstanding the pros of REITs investments - liquid, low barrier to entry, transparent etc - there are certain drawbacks as well. In addition to the risks mentioned in the aforementioned section such as volatility and dilution, REITs only offer investors exposure to core investment strategies. The realm of real estate investment is much bigger, including value-add and opportunistic plays that could yield attractive risk-adjusted returns. But REITs investors will not be able to access these opportunities.
- Owning physical real estate: Owning a physical real estate gives you the authority to manage your real estate. It is a good investment if you have a large amount of cash reserve as down payment is usually very high and there is a likelihood that your cash flow will suffer when there is no occupancy in your rental unit. You gain authority in decision making and management. However, you will take on all of the risk and need to be sufficiently equipped with the necessary expertise.
- Co-investing in real estate: Real estate co-investing is becoming popular. The idea of it is to co-own real estate properties with other investors. Usually, property sourcing and due diligence is done by a property co-investment company or manager. Subsequently, the opportunities (potential real-estate deals) will then be recommended to co-investors who are interested. Ownership of the property/properties is based on the percentage of capital injected by the co-investors to the fund. Typically the property investment company or property manager will be the minority interest in the property deal. Check out our article: REITs vs real estate co-investing to see a comparison between the two types of real estate investment.
In conclusion, REITs are a good way for investors to gain exposure to real estate. But they come with their set of limitations. To build a robust investment portfolio, investors should also consider alternative options such as co-investments to augment their real estate investment strategy.
Q and A
How to purchase REITs in Singapore? - You can purchase REITs just like how you purchase any stock, either choose a broker to purchase your desired REITs or create a CDP account and purchase REITs through a brokerage platform.
Here are some of the brokerage platform where you can purchase REITs:
How do REITs make money? - Equity REITs usually make money through rental income and management management fee. For hospitality and healthcare REITs they usually earn extra income through services which they provide.
How much to invest in S-REITs? - How much to invest highly depends on your financial situation and your investment objectives. REITs are not popular for their capital appreciation but they do return higher amounts of dividend yield as compared to other asset classes. As such, if you are planning for retirement and you have a large cash reserve, you may consider investing in REITs as you can enjoy the dividend payouts.
Why are REITs a good investment? - This is a subjective opinion. People may think REITs are a good investment as they may have compared with other high volatile assets classes such as the equity market. Some may think that REITs are a better investment because they pay out substantial dividends. However, as mentioned above there are risks behind investing in REITs, it is up to you to do your due diligence in analysing a REIT before investing.
How to value REITs? - There are many ways to analyse a REIT and there is no perfect way of doing it, because in the end of the day, REITs are still subjected to exogenous market influences which can affect its performance. Here are some common ways to value a REITs:
Net Asset value (NAV) - NAV is the summation of all the assets in a REITs, you can get this information from the yearly or quarterly balance sheet published by the REIT company. Sum up the total cash reserve and all the income generating properties, divide the total value by the amount of shares issued, you can get a good sense on whether you are overpaying for a particular REIT or you are getting a discount.
Dividend Yield - Dividend payout is an attractive feature of a REIT, to compare your yield return with other REITs, we usually use percentage yield to measure how “profitable” your REIT is.
Dividend yield = (annual dividend payout per share) *100 / share price
Higher dividend yield, the more your return on investment.
Using both NAV and Dividend yield you can get a good gauge on your ROI through buying a particular REITs, but do analyse the market condition and the management team of the REITs before investing in any.
What is DPU? - Distributed per unit (DPU) similar to dividend yield, it is the amount of cash receive annually for every unit of REIT you own.
What is WALE? - Weighted Lease Average Expiry (WALE) is a popular metric used in real estate, to measure the probability of the time taken for a unit to be unoccupied by tenants. A high WALE gives investors confidence in investing in a real estate or REITs portfolio.Sign Up at RealVantage
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