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Understanding real estate investment trusts (REITS)

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29 Oct 2018 | 8 min. read

Find out how real estate investment trusts (REITs) work, and what you should know if you are thinking of investing in one.

Key takeaways

  • REITs invest in real estate properties and distribute revenues generated from these assets (primarily rental income) at regular intervals to REIT holders.
  • REITs are professionally managed by REIT managers and property managers who charge a fee in exchange for their services.
  • There are a variety of REITs listed on the Singapore Exchange, and you can buy them in the same way as you would buy a stock.

What are REITs?

When you invest in a real estate investment trust (REIT), your money is pooled together with other investors' in a collective investment scheme that invests in a portfolio of income generating real estate assets such as shopping malls, offices, hotels or serviced apartments.

These assets are professionally managed and revenues generated from assets (primarily rental income) are normally distributed at regular intervals to REIT holders, after accounting for fees, such as REIT management fees and property management fees.

The REIT’s investment goal is to generate income distribution and long-term appreciation potential.

You can invest in them the same way as you would invest in stocks, through your broker.

How it works

A typical REIT structure works like this:

  1. Money is raised from unit holders through an initial public offering (IPO) and used by the REIT to purchase a pool of real estate properties.
  2. These properties are then leased out to tenants.
  3. In return, the income flows back to the unit holders (investors) as income distributions (which are similar to dividends)

Most REITs have annual REIT managers’ fees, property manager’s fees, trustees’ fees and other expenses that will be deducted from their profits before distributions are made.

Some REITs which hold properties in foreign jurisdictions may also be subject to taxation by the relevant jurisdictions. Investors can find information on these fees in the REITs’ prospectuses and financial statements.

The figure below shows a typical REIT structure.

 

Roles in a REIT

A REIT structure typically has the following key roles:
Trustee

The trustee’s duties are set out in the trust deed. The trustee is responsible for holding the assets of the REIT on behalf of unit holders. Other duties may include ensuring compliance with all applicable laws and protecting certain rights of unit holders.

The trustee is paid a fee for providing this service.

REIT manager or property manager

The REIT manager sets and executes the strategic direction of the REIT according to its stated investment strategy. For instance, it is responsible for the acquisition and divestment of the REIT’s properties.

In an externally-managed model, the REIT manager charges a management fee that includes a base fee and performance fee in exchange for its services. It may also charge additional fees such as acquisition and divestment fees.

A REIT manager typically appoints a property manager to manage the real estate properties of the REIT. The property manager’s responsibility includes renting out the property to achieve the best tenancy mix and rental income, to run marketing events or programs to attract shoppers/tenants and to upkeep the property.

In return, the property manager is paid a property management fee out of the assets of the REIT.

REIT sponsor

In some cases, there is a sponsor who sources the properties that are injected into the initial portfolio of the REIT and may continue to provide a pipeline of assets for the REIT.

Usually the sponsor also owns stakes in the REIT manager and the REIT.

Your rights as a REIT unit holder

In general, these are limited to the right to:

  • Require the REIT manager or trustee to administer the REIT in accordance with the provisions of the trust deed
  • Remove a REIT manager

To remove a REIT manager, unit holders have to call for a general meeting to vote on a resolution to remove the REIT manager. The call for general meeting must be made in writing to the REIT manager or trustee by at least 50 unit holders or such number of unit holders that together hold at least 10% of the REIT’s issued units.

The resolution to remove the REIT manager must then be passed by a simple majority of unit holders present and voting at the general meeting, with no unit holders being disenfranchised.

Before you invest: Things to note

Do not assume that REITs are low risk and that the dividend income is recurring. Read your prospectus and research reports to understand the investment objective and strategy of the REIT.

Look for information under the following three key areas:

  • Information on the REIT manager – their experience and track record, and, if applicable, the REIT’s sponsor and pipeline of assets
  • 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

REITs can have different structures, geographical or sector focus, and some REITs may carry more risk, such as political and regulatory risk, than others. You should:

  • 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 REIT’s 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.

Benefits of REITs

REITs have the following benefits:

Diversification – The risk arising from investing in one property is diluted when you invest in a pool of properties through a REIT.

Affordability – As an individual investor, you may not be able to afford a direct investment into a large asset such as office buildings or shopping malls. By investing in a REIT, you get to invest in these large assets in bite-size chunks.

Liquidity – It is easier to buy and sell units in a REIT than to buy and sell properties. REITs are listed on the stock exchange and you can trade units in a REIT throughout the trading day.

Tax benefits – REITs that distribute at least 90% of taxable income each year enjoy tax transparency treatment by IRAS (subject to certain conditions). Individual investors who receive these distributions also enjoy tax-exemption treatment.

Transparency and flexibility – You can access information on REIT prices and trade REITs throughout the trading day.

Investing in REITs versus property stocks

Although both are property-related, there are some differences between investing in REITs and investing in property stocks.

Most REITs have annual managers’ fees, property management fees, trustees’ fees and other expenses that will be deducted from their income before distributions are made. Most REITs have annual managers’ fees, property management fees, trustees’ fees and other expenses that will be deducted from their income before distributions are made.
REITS Property stocks

Business focus

Investment in income-generating properties

Generally property related, but may diversify into other unrelated activities or industries

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 taxable income each year to enjoy tax transparency treatment by IRAS

Subject to the decision of the board

Investment and leverage guidelines

Subject to Appendix 6 of the Code on Collective Investment Schemes

None

Tax-exempt income (dividend)

Yes

No

Management fees*

Yes

No

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

 

What are the risks?

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.
  • The prices generally reflect investors’ confidence in the economy, the property market and its returns, the REIT management, interest rates, and many other factors.

Income risk

  • Distributions are not guaranteed and are subject to fluctuations in the REIT’s income. For example, a REIT’s rental income may be affected if tenancy agreements could be renewed at a lower rental rate than before or the occupancy rate could fall.
  • Look out for whether the REIT has procured payment upfront or has contractual lock-ins of rental rates and other clauses in tenancy agreements.
  • 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 REIT’s value is from one or a few properties or a few tenants, you face a greater risk of loss should something happen to one of them.

Liquidity risk

  • A REIT may find it difficult to find buyers and sellers for its properties.
  • It may be difficult for REITs to vary their investment portfolio or sell its assets on short notice under adverse economic conditions or exceptional circumstances.

Leverage risk

  • Where a REIT uses debt to finance the acquisition of its properties, there is leverage risk.
  • If the REIT is wound up, its assets will be used to pay off creditors 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.
  • To refinance, they may need to borrow more (through bank borrowings or bond issuances) or undertake equity fund raising activities such as rights issues or private placements.
  • The refinancing cost could also be higher when loans are due for renewal.
  • Another risk is that the REIT is unable to secure refinancing and has 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.

Types of REITs

There are a number of REITS listed on the SGX. Here are the broad categories of REITs you can invest in and the typical properties they own:

  • Commercial REITs – office buildings
  • Retail REITs – shopping malls
  • Industrial REITs – warehouses, logistics facilities and data centres
  • Hospitality REITs – hotels and serviced residences
  • Healthcare REITs – hospitals and nursing homes

Checklist

Are REITS suitable for you?

Here is a checklist to help you decide whether to invest in a REIT.

What does the REIT invest in?

Read the prospectus and research reports to understand these key areas:

  • The sector and geographic focus (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)
  • The underlying assets (in particular the asset quality, such as branding of a shopping mall, occupancy rate and the tenant mix)

How is the REIT structured?

Read the “Investment Approach” and “Risks” portions of the 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 REIT’s 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. management fees, property management fees, trustees’ fees, acquisition and divestment fees etc)?
  • What is the gearing (leverage) and debt maturity profile of the REIT?
  • Are there unique features of the specific REIT which may give rise to additional risk?

What are your rights as a REIT unit holder?

Read the trust deed and the prospectus to understand the rights and interests of a REIT unit holder. In general, these are limited to the right to:

  • Require the REIT manager/trustee to administer the REIT in accordance with the provisions of the trust deed
  • Remove a REIT manager

What is the distribution policy?

Find out:

  • What is the expected frequency and timing of distributions from the REIT?
  • What are the adjustments made to income in determining the amount to be distributed?
  • What are the circumstances under which a REIT may not make distributions, e.g. insufficient cashflow?

Are you comfortable with the REIT's corporate governance?

Invest in the REIT only if you are comfortable with its corporate governance. For more information, you may refer the Governance Index for Trusts.

Does the REIT suit your needs?

Does the REIT’s structure and risk profile suit your risk appetite and investment time horizon, compared 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.

See also: Guide to shares: What you need to know before you invest

Last updated on 07 Nov 2018