Reviewed on 18 February 2020
Ever since the launch of CapitaMall Trust which is Singapore’s first REIT in 2002, REITs have taken Singaporeans by storm in the investment world. However, in the United States where REITs first originated from in 1961, it has already become an established investment product. By putting your money in REITs, you can invest in real estates like hotels, retail stores and hospitals which only the rich can afford in the past.
What are REITs?
REITs (Real Estate Investment Trust) are trusts that own and operate income-producing real estate. Investors’ money is pooled together in this collective investment scheme and placed in property investments. Income is generated through renting and selling assets and revenues are distributed at regular intervals to holders after accounting of relevant fees such as management fees.
Advantages of REITs
REITs is an investment vehicle available to investors in addition to the more conventional stock trading. However, there are several benefits that REITs possess over equities.
Regular Dividends & Tax Benefits
In many countries, REITs are required by law to distribute at least 90% of their taxable income as dividends every year. In Singapore, REITs will also enjoy tax transparency benefits from the tax authority (IRAS) when they distribute dividends. Investors who receive such dividends also get tax-exemption treatment. Thus, investors will be assured that they will be receiving dividends as long as the REIT is profitable.
Volatility & Diversification
In general, beta of REITs, which is a sign of volatility, is lower than equities and this reflects the nature of REITs’ predictable cash flows.
REITs help investors hedge risk as while REITs are still affected by general market trends, performance don’t necessarily track those of stock indices or bonds. REITs help investors diversify as instead of investing in a single property, they are investing in a pool of properties and occasionally, across countries.
The portfolio of each REIT is different. Most REITs are focused in certain categories of real estate such as Mapletree Logistics Trust only invests in high potential logistics real estate in Asia. Parkway Life REIT is a REIT that invests only in healthcare properties. There are others out there that solely focuses on commercial or retail real estate and in Singapore, there are currently a total of 32 REITs in the market.
Why are people favoring REITs during this period of economic uncertainty?
REITs are considered the 2nd least trade sensitive sector in US. Steel and lumber imports are exposed to the tariffs thanks to the trade war and this has forced many upcoming projects to be delayed already since construction costs have ballooned considerably. Future real estate supply growth has thus slowed and with the American economy still going relatively strong indicates that property demand may remain strong.
According to analysis published by Cohen and Steers, an investment manager from New York, US REITs have traditionally outperformed the S&P 500 by more than 7% annually in the late cycle of the economy since 1991. Investors will take advantage of the fact that there is meaningful downside protection for themselves during recessions.
The US Federal Reserve has signaled during a speech in June 2019 that they are looking at cutting rates sometime in the year and true to his words, Fed Chairman Jerome Powell announced a 25-basis points rate cut at the end of July. A lower interest rate environment benefits REITs as that implies lower interest repayments and hence, higher Distributions Per Unit (DPU) attributable to investors. Yield levels for investment-level bonds will suffer further going forward from their already very unattractive levels. This has forced some to buy previously issued bonds that promise higher yields directly driving up prices or turn to alternatives like REITs.
In Singapore, the sense of optimism also stems from the fact that the Monetary Authority of Singapore (MAS) does not directly set its own interest rates and thus, a Fed rate cut will directly affect the benchmark Singapore Interbank Offered Rate (SIBOR) and interest repayments. The recent proposal by MAS to increase the gearing limits for Singapore REITs (S-REITs) from 45% to between 50-55% may also spur acquisitions for S-REITs, leading to Credit Suisse to report that they believe S-REITs’ valuations will stay elevated.
However, analysts from several market research houses so far point to a possible declining performance for S-REITs in the second half of this year. Several S-REITs appear to be overvalued and there could be some short-term sell-off pressure leading to capital losses. Global growth is expected to slow further in 2019 and weaker demand from China compounding other fallout woes from the trade conflict will likely create some trying conditions for property markets worldwide. Therefore, it would be wise for investors to be more prudent in their REIT investments going forward.
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