What Are REITs and How Do They Work?

Real Estate Investment Trusts (REITs) are companies that purchase and manage income-producing real estate on behalf of investors. In the case of REITs, investors pool their money to invest in a portfolio of properties. REIT portfolios may include properties such as shopping malls, hotels, offices or serviced apartments, which are leased out to generate rental income. After deducting expenses like REIT management and property management fees, the profit is redistributed to investors as income distributions (similar to dividends). REITs are commonly traded on stock exchanges, such as Singapore Exchange (SGX), providing investors with a convenient way to invest in real estate.

Why Invest in REITs?

Investing in REITs offers investors exposure to real estate without the need for direct property ownership. Direct real estate investment is capital-intensive, requiring the purchase of physical property and rental management, which can be both time-consuming and demanding, as it requires extensive experience and knowledge to succeed. This is why REITs are seen as a more accessible and ‘affordable’ option, allowing individuals to invest in substantial assets that may have previously felt beyond reach.

Here are other key factors behind the appeal of REITs:

Accessibility, Low Barrier of Entry

REITs can be bought and sold like stocks, making them more accessible to average investors compared to direct property investment. This liquidity can be attractive, especially in a market with fluctuating performance. REITs also have low barriers to entry – you can start investing in portfolio of properties with as little as a few hundred dollars.

Income Generation, Attractive Dividend Yields

REITs are known for providing attractive and consistent dividend yields, which can appeal to income-seeking investors. As part of income/cashflow investing, REITs must pay out at least 90% of their taxable income to unit holders as dividends each year. This provides investors with a relatively steady income stream.

Even with fluctuations in performance, the income potential remains a significant draw. For example, at the end of June 2024, the average yield for REITs is still noticeably higher than government bond yields with the 12-month average dividend yield of S-REITs at 8.1% compared to the 10-year Singapore benchmark government bond yield of 3.2%, according to SGX data.

Tax Benefits (for Singapore REITs only)

In general, dividends received from Singapore REITs are not subjected to taxes in Singapore, but rental income from physical properties are.

Diversification

Investing in REITs allows investors to gain exposure to a diversified portfolio of properties without needing to buy physical real estate. It provides the benefit of diversification as REITs invest in a portfolio of properties as compared to putting all eggs into one property.

Professional Management

REITs are managed by professionals who make decisions about property acquisition, management, and leasing, which can provide assurance to investors who may not have the expertise to manage real estate directly.

Lower Fees

Annual management fees are typically lower compared to fees associated with buying physical property which consists of charges like stamp duties, legal fees, agent commissions and insurance.

Exploring Different Types of REITs

REITs are typically classified by the type of real estate portfolio they invest in, which may focus on a single country or multiple countries. Broadly speaking, they can be classified into seven categories:

Retail REITs

Retail REITs specialize in owning and managing shopping malls, retail centers, and other retail spaces. These REITs benefit from rental income provided by a wide range of retail tenants. Retail REIT performance is typically closely tied to consumer spending, making it a reflection of the broader economic climate and consumer confidence. Look out for REITs with stable anchor tenants and strong tenant management strategies that can adapt to fast-changing market conditions.

Commercial REITs

Commercial REITs invest in office buildings and corporate spaces. They focus on leasing office space to businesses and professional services. Key factors affecting the performance of Commercial REITs include occupancy rates, lease terms and overall demand for office spaces driven by economic conditions and corporate activities.

Hospitality REITs

Hospitality REITs manage hotels, resorts, and serviced residences. These REITs earn income from room rentals and related services, often catering to both business and leisure travelers. The performance of hospitality REITs is influenced by occupancy rates, tourism trends, and broader economic conditions that affect both business and leisure travel.

Healthcare REITs

Healthcare REITs focus on properties such as hospitals and medical centers. These REITs earn income from leasing space to healthcare providers and related services. The performance of healthcare REITs is driven by factors such as healthcare demand, tenant stability, government policies and the aging population’s rising need for medical facilities.

Industrial REITs

Industrial REITs invest in industrial properties such as data centers, warehouses, manufacturing facilities, and logistics hubs. They generate rental income from companies needing industrial space for production or storage. The performance of industrial REITs can be influenced by e-commerce growth, supply chain trends, demand for logistics and storage space.

Residential REITs

Residential REITs own and manage residential properties such as apartment buildings, serviced apartments, condominiums, and other types of housing. They generate income through rent and lease agreements with tenants. Key factors that can impact the performance of residential REITs include rental demand, housing market trends, population growth, and economic conditions that affect tenant occupancy and rental rates.

Other Property Sectors

Some REITs may invest in specialized or niche property sectors, including mixed-use developments or properties not easily categorized into the other types. These could include infrastructure and transportation. The performance of specialized REITs is typically influenced by industry-specific factors and regulatory environments within those unique markets.

Understanding The Management Structure of a REIT

REIT Investor

The investors who bought units in a REIT.

REIT Manager

– The REIT manager usually refers to the investment company which manages the REIT’s portfolio and strategic decisions.
– It is more ideal to go with a reputable company when choosing a REIT to invest in.

Property Manager

– Contracted to provide property management services for the REIT’s properties, i.e. upkeep of property, marketing events to attract tenants.

REIT Trustee

– The registered legal owner of the REIT’s assets.
– Holds the REIT’s assets in trust on behalf of the unit holders.
– Provides oversight duties such as ensuring the REIT complies with applicable laws and regulation.

Properties

The properties the REIT owns.

Key Considerations in Selecting a REIT

Dividend Per Unit

– The amount of dividends paid out per unit/share of the REIT.
– Unlike dividend yield, this metric will not vary with the REIT’s unit price.

Dividend Yield

– Calculated by dividing the REIT’s dividend per unit by its unit price
– Used to broadly compare a REIT’s return against other REITs and other types of investments like bonds and dividend stocks.
– Because dividend yield is based on the REIT’s price, a low dividend yield may simply indicate higher REIT prices rather than low dividend.

Property Yield

– Calculate by dividing the REIT’s net operating income by its net assets.
– Tells you how much income a REIT can generate from its property portfolio.

Gearing Ratio

– Calculated by dividing a REIT’s total debt by its total assets.
– A REIT with lower gearing ratio would tend to be more conservative.
– A REIT that is chasing growth would tend to have higher gearing ratio, which also implies higher risk.

Property Portfolio

– Looking at the properties held by the REIT
– Familiarize yourself with the geographical area and sector that the REIT is in.
– Factors to consider can be tenant occupancy rate, location, size and regularity of crowd.

Macroeconomic Conditions

– Analyze whether there is any macroeconomic news that could adversely affect the broad real estate market, e.g. low interest rates make property and REITs more attractive.
– Consider how news would impact the REIT’s specific sector, e.g. decreased consumer spending may hit REIT’s which invest in malls the hardest.

Risks of Investing in REITs

There are some risks to be aware about when it comes to REITs:

Market Risk

– REIT prices fluctuate on the open market just like equities.
– Prices of the underlying properties are themselves subject to market risk.

Business Risk

– Underlying properties may face adverse business conditions which might affect tenancy and thus income.

Leverage / Interest Rate Risk

– REITs tend to have large borrowings to fund the acquisition of their assets. If interest rates rise suddenly, the interest expense cost for REITs will also increase, thus lowering their profits and yields.
– Also, rising interest rates could make other investment instruments more attractive and lead to selling pressure on REITs.
– However, rising interest rates due to economy growth can be positive for REITs and the value of real estate assets it owns as well.

Liquidity Risk

– While the REIT units are themselves liquid, the underlying property asset remains illiquid (may be difficult to find buyers and sellers for its properties).

Concentration Risk

– REITs whose property portfolio only consists of a few properties are more exposed to adverse events.

Credit/Refinancing Risk

– REITs with high leverage may be at risk of default if they are unable to pay their loans.
– If the REIT is wound up, its assets will be paid off to creditors first before unit holders.

REITS vs. Stocks: Key Comparisons

How Do REITs Compare to Stocks?

Similarities
– REITs & Stocks can be traded on stock exchanges
– REIT & Stock prices move on the open market according to supply and demand
– There are REIT ETFs that track the broader REIT market just like there are stock ETFs which track the broader stock market.

Differences
– REITs are legally obligated to pay out at least 90% of taxable income each year as dividends to unit holders.
– REITs can only invest in real estate properties such as shopping malls, hotels, industrial facilities and healthcare properties.

Pros and Cons of Investing in REITs vs. Stocks

REITs typically offer steady income through regular dividends, diversification through investing into a portfolio of real estate properties, and liquidity as they are traded on stock exchanges. However, they are sensitive to interest rate changes because rising interest rates increase borrowing costs for real estate companies and may potentially make bonds more attractive, which can lead to a decline in REIT prices. Also, REITs may have limited capital growth and often include management fees.

Stocks, on the other hand, provide higher growth potential and a wide range of investment options, with the possibility of both dividends and capital gains. However, they come with higher volatility because stock prices can fluctuate significantly due to market conditions, company performance and economic factors, leading to more unpredictable returns. Additionally, investing in stocks may require more research and monitoring to make informed decisions.

Conclusion: Summing up on REIT Investing

Investing in REITs is one way for investors to add potential dividend generating real estate to their investment portfolios. While they are not risk-free, they can possibly be valuable additions to the portfolio of investors who have done their due diligence.

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This article is brought to you by Standard Chartered Bank (Singapore) Limited. All information provided is for informational purposes only.