Real Estate Investment Trusts



Real Estate Investment Trusts (REITs) are often described as instruments that offer investors the opportunity to invest in a professionally managed portfolio of real estate, through the purchase of a publicly-traded investment product. Individuals invest in a REIT by purchasing units of the trust, similar to shares of a common stock. The investment objective of REITs is to provide unit holders with dividend income, usually from rental income, and capital gains from the profitable sale of real estate assets. While this may sound attractive, it is important to know that REITs, like other investment products, are not completely free from risk.

For instance, as with all stocks, REITs do carry market risks. The value of units in publicly traded REITs can therefore fluctuate and investors may receive more, or less, than the original purchase price.

This Guide aims to help you understand what REITs are and what you should consider before investing in them. It highlights the benefits and risks of investing in REITs, what you should look out for in the prospectus and other important information.

What is a REIT?

REITs are collective investment schemes that invest in a portfolio of income generating real estate assets such as shopping malls, offices, hotels or serviced apartments, usually established with a view to generating income for unit holders. Assets of REITs are professionally managed and revenues generated from assets (primarily rental income) are normally distributed at regular intervals to you, as a unit holder. Investment goals for REITs are much the same as the goals of an investment in stocks – current income distribution and long term appreciation potential.

As a unit holder of a REIT, you share the benefits and risks of owning a portfolio of property assets which typically distribute income at regular intervals. REITs normally have regular cash flows as their revenues are derived from rental payments under contractually-binding lease agreements with specific tenures, in most cases.

Units of listed REITs are listed on the Singapore Exchange (SGX) and are bought and sold like other listed securities.

The first Singapore REIT was launched and listed on the SGX in July 2002. Singapore-listed REITs offer investors access to a diversity of real estate assets including retail malls, office buildings, industrial properties, hotels, serviced apartments and hospitals.

TIP: Do not assume that REITs are low risks and that the dividend income is recurring. Read your prospectus and research reports to understand the investment objective and strategy of the REIT, and look for information under the following three key areas:

  • information on the management company and trustee, their experience and track record;
  • information on properties to be put in the REIT (in particular whether you are familiar with the geographical and sector exposures of the REITs you intend to invest in);
  • other investment information such as dividend policy and fees and charges

How are REITs typically structured and what do they invest in?

REITs are structured as trusts and thus the assets of a REIT are held by an independent trustee on behalf of unit holders. The trustee has duties as laid out in the trust deed for the REIT which typically include ensuring compliance with all applicable laws, as well as protecting certain rights of unit holders.

In a typical REIT structure, money is raised from unit holders through an Initial Public Offer (IPO) and used by the company to purchase a pool of real estate properties. These properties are then leased out to tenants; and in return, the income flows back to the unit holders (investors) as income distributions (dividends).

In some cases, a sponsor or a major shareholder is also present. For example, if a property developer launches a REIT, he may choose to keep X% (say 30% to 50%) stake in the REITs itself. Like any other investor, the developer in this instance will receive income distributed as dividends, where applicable.

The underlying real estate properties are managed by a property manager and the REIT itself is managed by a REIT manager in exchange for a fee. The underlying assets are held by a trustee on behalf of the investors. Each party receives fees in return for his or her services. Most REITs have annual managers’ fees, property manager’s fees, trustees’ fees and other expenses that will be deducted from their cash yields before distributions are made. Some REITs which hold properties in foreign jurisdictions may also be subject to taxation by the relevant jurisdictions.

TIP: Always read up on the REITs you are considering. REITs can have different structures, geographical or sector focus, and some REITs may carry more risk, such as political and regulatory risk, than others.

  • Read the “Investment Approach” and “Risks” portions of your prospectus for information on the various risks of the specific REIT you intend to invest in. Note that the risk elements may differ greatly between REITs depending on their investment objective and strategy, geographical and sector focus, quality of the underlying real estate properties, experience of the REIT manager, and the income distribution policy.
  • Consider if the REITs structure and risk profile suit your risk appetite and investment time horizon.
  • Do not invest in a REIT if you do not understand or are not comfortable with its investment objective and strategy.

What are the benefits and risks of REITS

As with all investment products, it is important to weigh the risks and benefits and assess whether the product fits with your risk appetite and your overall financial plan.

Benefits of REITs

The unique characteristics and features of each REIT, such as its portfolio of assets and focus on generating income as regularly as possible, can translate into benefits for investors.

Diversification: REITs typically own multi-property portfolios with diversified tenant pools. This reduces the risk of relying on a single property and tenant which you face when you directly own a real estate property. For example, if the MRT station next to your apartment closes down, its value would probably fall. The impact of such “stand-alone” risk is diluted when you invest in a pool of properties through a REIT.

You could diversify further by selecting REITs based on the type of properties or region you want to invest in (Singapore listed REITs, or S-REITs have a diverse range of assets such as hotels, shopping malls, office buildings; in Singapore as well as other countries such as China).

Affordability: The REIT investor enjoys the advantage of the power of the pool of capital to acquire interests in much larger opportunities than would be available to their personal capital alone. For example, individual investor may not be able to afford a direct investment into a large asset such as Suntec City or shopping malls in China. By investing in a REIT, you get to invest in these large assets in bite-size chunks.

Liquidity: Compared to investing directly in real estate properties, REIT investment offers the advantage of liquidity – the ease of converting assets into cash. REITs are listed on the stock exchange and you can trade a REIT throughout the trading day, and it is easier to buy and sell a REIT than to buy and sell properties.

Tax Benefits: Individual investors enjoy a tax-exempt distribution which comes in the form of dividends in the REITs structure.

Transparency and Flexibility: The process of buying or selling a REIT is transparent and flexible, just like trading stocks listed on the exchange. Investors can access information on the REIT prices and trade REITs throughout the trading day. Moreover, there are a lot of external controls and monitoring of REITs, which increase transparency and corporate governance. For example, REITs are required to distribute at least 90% of taxable income each year to enjoy tax exempt status by IRAS (subject to certain conditions) .

See Table 1 for a comparison of features between investing in REITs and investing in property stocks.

Table 1: Comparison of features between REITs & Property Stocks 

REITs Property Stocks
Business Focus Investment in income-generating properties Generally property related, but may diversify into other unrelated activities or industries
Safe Custody of Properties Properties are held on trust by an independent trustee Properties are held by the company

Dividend Policy

Must pay out at least 90% of net income after tax Subject to the decision of the board
Investment and Leverage Guidelines Subject to the Property Funds Appendix in the Code on Collective Investment Schemes None
Tax-Exempt Income (dividend) Yes No
Traded Through Broker Yes Yes
Management Fees Yes No
Clearing Fees Yes Yes
Brokerage Commission Yes Yes
Settlement Third Business Date after Trade Date Third Business Date after Trade Date

*Most REITs have annual managers’ fees, property management fees, trustees’ fees and other expenses that will be deducted from their cash yields before distributions are made.

Risks of REITs

The risks associated with a REIT investment vary and depend on the unique characteristics and features of each REIT, as well as the geographical location of the investments. Do not simply look at the expected yield, but also consider the concentration, quality and lease length of the underlying properties.

Some of the risks associated with investing in REITs include:

Market Risk: REITs are traded on the stock exchange and the prices are subject to demand and supply conditions, just like other stocks. Investors could receive less than the original investment amount when they sell their units in a REIT. The prices generally reflect investors’ confidence in the economy, the property market and its returns, the REIT management, interest rates, and many other factors. Like other stocks, investors must be able to tolerate such price movements.

Income Risk: Dividends may not be paid if a REIT reports an operating loss. For example, tenancy agreements of the underlying properties could be renewed at a lower rental rate than the previous agreement or the occupancy rate could fall. You should consider whether the REIT has taken any measures such as procuring payment upfront or contractual lock-ins of rental rates and other clauses in tenancy agreements. Similarly, if the underlying properties are financed by debts, there is a refinancing risk when cost of debt varies. A higher cost of debt may also reduce the income distributions to unit holders.

Concentration Risk: If a substantial portion of the value of a REIT’s assets is derived from one or a few properties, you may be exposed to a greater risk of loss if something untoward should happen to one of these properties. Similarly, if a REIT depends on only a few tenants for its lease income, you are exposed to a greater risk of these tenants not being able to fulfill their lease obligations.

Liquidity Risk: Although investors are able to exit their investments easily by selling it on the exchange, the real estate fund itself may be relatively less liquid compared to funds investing in financial securities such as stocks and bonds. This is because it is difficult to quickly find buyers and sellers for property, especially if the value of the property is high. As a result, it may be difficult for REITs to vary their investment portfolio or sell its assets on short notice should there be adverse economic conditions or exceptional circumstances.

Leverage Risk: Where a REIT uses debt to finance the acquisition of underlying properties, there is leverage risk. As is the case with other listed companies, in the event of an insolvency of the REIT, the assets of the REIT will be used to pay off debtors first. Any remaining value will then be distributed to unit holders.

Refinancing Risk: As REITs distribute a large amount of their income to unit holders, they may not have the ability to build up cash reserves to repay loans as they fall due. Thus they will typically seek financing by entering into new borrowing agreements, or other capitalization measures such as rights or bond issues. One potential risk is higher refinancing cost when loans are due for renewal. Another risk is that a REIT which is unable to secure refinancing may be required to sell off some properties if they are mortgaged under the loan. These risks could affect the unit price and income distribution of a REIT.

Other Risks: While some REITS can offer diversity based on the type of properties or region you want to invest in, such diversification could carry other risks such as sector and country regulation risk.

Conclusion

As with any other investment product, investors should also take time to understand the product and consider whether it is suitable for them. Here are a few key things you should check before deciding whether to invest in a REIT.

i) What does the REIT invest in?

Do not assume that all REITs come with low risks and are intended for long term investing. Read your prospectus and research reports to understand these key areas:

  • the sector and geography factor (in particular the stage of property cycle in the assets’ home countries, the economic outlook for that country, any political or regulatory risk, any tax considerations); and
  • the underlying assets (in particular the asset quality, such as branding of a shopping mall, occupancy rate and the tenant mix).

ii) How is the REIT structured?

Read the “Investment Approach” and “Risks” portions of your prospectus for information on the various risks of the specific REIT you intend to invest in. Note that the risk elements may differ greatly between REITs depending on their structure.

Do also find out:

  • Who are the people managing the underlying assets? For example, the management quality, such as its reputation and track record, its strategy for growth.
  • If there is a sponsor, who is the sponsor and what is the strength of the sponsor?
  • What are the expected fees (i.e. brokerage commission, management fees, trustees’ fees & expense ratio)?
  • What is the gearing (leverage) and debt maturity of the REIT?
  • Are there unique features of the specific REIT which may give rise to additional risk?

iii) What is the dividend distribution policy?

Find out:

  • What is the expected frequency and timing of dividend payment?
  • What are the adjustments made to income in determining the amount to be distributed?
  • What are the circumstances under which a REIT may not pay dividends, e.g. an operating loss, downward revaluation of properties, or insufficient cashflow?

iv) Does the REIT’s structure and risk profile suit your risk appetite and investment time horizon?

v) How does the REIT you are considering compare with other investment options?

Last but not least, if you find that you do not understand the REIT or are not comfortable with its structure and risks, do not invest in it.

 

The above information is prepared in collaboration with the Singapore Exchange Limited (SGX).