Wednesday, August 13, 2014

Making Money from Real Estate Investment Trusts (REITs)

Singaporeans' obsession in property investments is well known for many years. Since property prices are currently so sky high in Singapore, the next best way of owning a property is through REIT investment. Many Singaporeans typically invest in Real Estate Investment Trusts (REITs) with a view of diversifying their portfolios and for the dividend income. But what is exactly a REIT and do investors realize that REITs do carry market risks? Many investors assume that REITS are low risks and that dividend income is recurring. Is this true? In this article, I would touch on the key aspects of REITs and what we should look out for before investing in REITs. I need to clarify that I have never invested in REITs before and do not believe in the merits of investing in REITs as well. This research on REITs is primarily for awareness sake and is not meant as a form of inducement to buy REITs.

According to SGX website, a listed REIT consists of multi-properties, such as office, shopping malls, hotels or serviced apartments. The revenues generated from the underlying assets are distributed to unit holders at regular intervals. Units of listed REITs are bought and sold like any other securities listed on exchanges at market-driven prices. Some investors may confuse REITS with unit trusts. This is because, like unit trusts, REITs are managed by approved fund managers and involve trustees approved by the Monetary Authority of Singapore. The key difference between unit trusts and REITS is unit trusts normally own a portfolio of securities, while REITs primarily own physical real estate assets and real estate-related assets. In addition, unlisted unit trusts can only be bought and sold through the manager of the unit trust fund at prices usually quoted at the end of each trading day. Listed REITs, on the other hand, are bought and sold through the stock market during trading hours.





How are REITs structured and why is it important for the investors to know? According to MoneySense, when a company decided to launch a REIT, money is raised from the unit holders during the IPO offering phase. The company would use the proceeds to buy a pool of real estate assets. Sometimes, the REIT might even finance the purchase of assets through debts. The assets of a REIT are held by an independent trustee who is responsible for safeguarding the interests of the unit holders and ensuring that the vehicle complies with the applicable laws in Singapore. Investors have to pay trustee fees. On top of appointing an independent trustee, a REIT itself must be managed by a property manager for a fee. The management fees will be deducted from the income yield before distributions are made. As if the structure is not confusing enough, sometimes a sponsor or major shareholder might be present. This happens when the developer for the REIT choose to retain a certain amount of shares stake in the REIT itself, so as to receive income dividends.

The complicated structure of a REIT means that investors need to understand the risks and rationalize whether the investment strategies are aligned to their risk profiles. This is because different REITs can have different structures, political and regulatory risks. Do not assume that REITs are low risk and that the dividend income is recurring. Always make it a point to read the prospectus and research reports to understand the business structure, dividend policy and management fees.


Many finance bloggers and investors claimed they understand REITs well but I suspected otherwise. In 2009, the risk of bankruptcy in Singapore REITs became very high due to falling asset values caused by lower forecast on occupancies and rentals. This led to banks shunning away from giving loans to REITs and as a result, the Monetary Authority of Singapore had to intervene to prevent the situation from worsening. Therefore investors need to be aware of the leverage and refinancing risks that REITs carry. Investors need to understand that in the event of insolvency, the assets of the REIT would be used to pay off the debtors first. So investors should check whether the REIT is able to build up cash reserves after distributing the income to unit holders.

In conclusion, investors should make the effort to understand the product before deciding whether to invest in a REIT. Do not assume REITs are low risk investment products just because they distribute incomes. Understand the business, structure, fees, leverage and regulatory risks before parting away your hard-earned money.

Magically yours
SG Wealth Builder

7 comments:

  1. Well said.

    How many of us are fully aware of leverage gains and double edged sword of using leverage?

    In good times, nobody care!

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    1. It is only during financial crises that the real champions stood out!

      Regards,
      SG Wealth Builder

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  2. Good piece. Thanks for sharing. I recall during the Financial Crisis, several REITs got into serious trouble and were bailed out by their parent sponsor or had to raise Rights Issues from shareholders. Instead of receiving the distribution yield as income, now have to pay some more. Still, I view REITs as a reasonably more diversified alternative to personally owning properties for rental income.

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    1. Agreed that REITs are good way of diversifying our portfolio but for me, I would limit to only two REITs in my investment portfolio. Beyond that, there might be concentration risks.

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  3. Nice piece of coverage on REIT! Thanks for sharing...

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  4. So credit rating and current gearing of a REIT is more important than the DPU yield. And the market usually priced it accordingly. 8% to 10% yield given by the Market for a particular REIT, there must be a reason for it. And the market is usually right. There is no "free-lunch" really!

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  5. It's a double edged sword.

    Investors need to see the "yield" from the inside and not outside.

    ReplyDelete