Yes, Real Estate Invest Trusts (REITs) are attractive. With about 6-8% yield, they are certainly mouth-watering investments in view of the paltry low bank interest rate. When REIT was first introduced as SingMall Property Trust in early 2000, it was unsuccessful and was forced to scrap. It was then re-packaged and launched in the following year with great success. Since then, REITs did not look back. In total, REITs have been in the local market for about 15 years. To date, there are about 40 REITs trading on SGX.
If one were to look at the performance of REITs for the past 5 years, they had generally advanced about 10-15%. And if we extend the reference point further back to the Global Financial Crisis (GFC), the increase should be about 30-40%. Given the unit price growth and the relatively high yield, the investment is considered decent (though I can’t say they are absolutely fantastic). Disregarding the business factors that affect each individual REIT, the two macro-economical factors that fuelled this growth were the state of the economy and the falling interest rate.
Needless to say, the state of economy is a key factor to fuel REIT prices. It is this factor that pushes up rentals in general, be they in the retail, office or industrial sectors. This translates to higher rental income of REITs, thereby benefiting the unit-holders.
The other factor is the falling interest rate. Falling interest rate tilts the balance in favour of borrowers at the expense of savers. Borrowing gets cheaper, and so is the depositor’s return. Unlike in a traditional company when management can decide to pay off the debts using their cash hoard or profits, REIT managers have less propensity to pay off their debts compare to increasing the distribution to unit-holders so long as the debt falls within the statutory requirement. Hence, at any one point in time, a REIT is likely to have some kind of borrowing. With a distribution of 90% of its taxable income to unit-holders, a REIT is essentially an “asset-rich cash-poor” legal entity. So, when there is an opportunity knocking at the door to purchase a property, the REIT manager would either have to look for new bank borrowing, and if the expected borrowing goes beyond the borrowing ceiling, they have to go to investors for more fund. So the 6-8% distribution that was given to unit holders over the past few years can be negated by just one single right exercise bringing down the distribution to be the same as blue-chip shares in the region of 3-5%. This may still be acceptable as there would be a bigger expected rental income as a result of the new real estate investment, the problem arise when the there is a general decrease in the real estate prices. This may cause the debt to exceed the permissible gearing ratio, and the REIT has no choice but to raise equities through rights issue in order to bring down its debt to meet this requirements.
For the last 5 years or so, these two factors have benefitted the REITs, that is, pushing up the price of REITs. But can these two factors continue to fuel REIT prices? Frankly, I think we need to be extremely careful going forward. When the previous FED chairman, Ben Bernanke, first spoke about the possibility of tapering in bond purchases during May 2013, the REIT prices fell between 15-25% across the board in the next few days that followed. Now, with the interest rate hike on the cards, it is also likely that REIT yield would also increase as well, meaning that REIT prices may become toppish, and possibly be on its way down depending on the aggressiveness of the interest rate hike. In fact, if one were to examine carefully, most REIT prices did not actually increase since his speech in May 2013. They have been quite range bound and to certain extent, exhibited significant volatility as central bankers were deliberating on interest rates movements. Most of the advances in REITs prices have actually been during the recovery after the GFC as well as between September 2012 when the QE3 (US$80b monthly bond-purchasing program) started and end May 2013 when Ben Bernanke conceived the idea of bond tapering.
Frankly, I am neutral about REIT investments. The high yield is there for a reason, and it should not be used as an absolute yard-stick to buy a REIT. In fact, going forward, the yield can get even higher if the interest rates are on the rise. The way I see it is that the danger is, generally, not about individual REIT as each should be studied based on its own merits. The real danger is when we get too obsessed with high-yield investments and hold too many REITs (or any high-yield instruments) and this can result in capital losses when the tide turns.
Remember this. Interest rates have been at historical low even before the GFC. Anything can happen in future.
Brennen has been investing in the stock market for 26 years. He trains occasionally and is a managing partner for BP Wealth Learning Centre. He is also the author of the book – “Building Wealth Together Through Stocks” which is available in both soft and hardcopy.