5 Questions On... Investing in REITs

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12 Mar 2020 | 5 min. read

If you are seeking a regular, moderate income stream, REITs may be an investment to consider. We speak to Ms Nupur Joshi, Chief Executive Officer of the REIT Association of Singapore (REITAS), to find out more about REITs and the metrics to consider when you are picking a REIT.

Key takeaways

  • REITs are a long-term investment. Take time to do your homework as your intention should be to hold the investment for the long term.
  • Adding REITs to an investment portfolio helps you to diversify your portfolio risk as REITs are typically not highly correlated with other asset classes like equities and bonds.

What is a REIT? And how does one earn from investing in REIT?

REITs are funds – investment capital pooled from many investors – that invest in a portfolio of income-generating real estate assets, such as shopping malls, offices, hotels, industrial properties etc.

When these properties are rented out, part of the rental income collected is used by the REIT manager to pay out sums of money – called distributions – to investors of the REIT from time to time; typically every three or six months.

The distributions are effectively what’s left of the rental income after deducting expenses to manage the fund, manage the property, etc.

So owning a REIT is like owning small stakes in a collection of properties and as a REIT investor, you get your share of the rental income from these properties. All things being equal, higher rental income would lead to higher distributions. Rental income can go up either due to higher rental rates and/or higher occupancy rate.

In addition to regular distributions there is also the possibility that the unit price of the REIT in the stock exchange may go up over time if investors believe in the long-term prospects of the REIT. However do note that all investments including REITs have an element of risk and your investment returns are not guaranteed.

What are the advantages of investing in REITs over actual properties?

 

One, you require lots of money to invest in physical properties. For example, an office building or a retail mall costs millions of dollars. To invest in a REIT, on the other hand, you only need as little as a few hundred dollars to own properties – albeit with many other investors.

 

Two, directly owning a physical property means you have to manage its upkeep, make sure your tenant is happy, and when the lease expires, either get the lease renewed or find a replacement tenant. All this takes time, effort and expertise. But if you own a REIT you don’t have to worry about all these as the REIT manager will take care of all these tasks.

 

Three, you can sell your stake in a REIT any time you want quite quickly as REITs are actively traded on the stock exchange. This is different from owning a physical property, which usually takes much longer to sell.

 

What types of investors are REITs suitable for?

 

If you are seeking a regular, moderate income stream, REITs may be something to consider. They can form a suitable component in any investor’s portfolio, regardless of age.

 

Adding REITs to an investment portfolio helps you to diversify your portfolio risk as REITs are typically not highly correlated with other asset classes like equities and bonds.

 

What this means is that the price of REITs may not necessarily move in the same direction as that of other equity stocks or other bonds. For example, if the STI is going down (or up), it may not necessarily mean that the price of REITs are also going down (or up). This can potentially reduce the volatility of returns of your investment portfolio.

 

REITs are a long-term investment. As such, if you are looking to buy a REIT, take time to do your homework and understand the strength of the REIT manager and its property portfolio.

— Ms Nupur Joshi, Chief Executive Officer, REITAS

 

What are the key pieces of data that investors should find out (and where can they find it) before investing in a REIT?

 

There are many metrics to look at when you want to assess the investment potential of a REIT. An important criterion is the REIT manager’s track record. Do they pay regular distributions; in other words, can they consistently manage to rent out properties, pay for property expenses, management fees and interest cost and still have a regular amount to distribute to unitholders?

 

No one can predict the future but a good way to check a manager’s track record is to check the REIT’s distribution per unit (DPU) and net asset value (NAV) per unit for the last few quarters or years. Has it been going up, staying steady or going down? A REIT with a good track record will generally have either a stable or slightly growing DPU and NAV per unit.

 

The quality and location of the REIT’s properties are very important criteria to consider. Are the properties in a location that is convenient for tenants? Are the buildings of good quality or do they look old and in need of a refurbishment? The answer to these questions will determine the occupancy rate of the building.

 

The quality of the REIT’s tenants is also important – are these established companies in their sector who are financially strong and doing well or small companies who are just starting out?

 

There are other metrics that are useful to take note of – what is the average length of the leases that the tenants are signing?

 

Short leases e.g. 1-3 years means that the landlord (i.e. REIT manager) will need to keep renewing tenants every one to three years. This is good when market rents are increasing as the landlord can use the opportunity to raise rents when the lease comes up for renewal.

 

Long leases e.g. over 5 years have their own advantages and disadvantages – while the rental income is reasonably certain for a longer duration, say 5 years, there is also no scope to increase rental rates if market rental rates are rising. However most long leases usually have some built-in rental escalation built into their lease contract, so that is again something to take note of.

 

Then there are financial metrics to consider. How much debt has the REIT taken, i.e. what is its gearing (aggregate leverage), and when is this debt due? In general, it is good if a REIT has its different debts coming due in different years so that it does not have the pressure to get a bank to roll over all its debt at once.

 

You can find all these information on presentation slides, press releases and the annual reports on the REIT’s website. Analysing a REIT (like any investment) requires some work but once you understand the company well, you will find investing to be both interesting and (hopefully) a rewarding experience.

 

Are there times when REITs are more attractive as investments?

 

REITs are a long-term investment. As such, if you are looking to buy a REIT, take time to do your homework and understand the strength of the REIT manager and its property portfolio. Once you have done this and feel comfortable with the merits of the investment one should not try to time the market as your intention should be to hold the investment for the long term.

 

 

Tip

Learn more about past and current industry trends from REITAS’ website (www.reitas.sg), where there are reports from property consultants, SGX, among others.

Last updated on 06 Apr 2020