Blog #20 A Primer on REITS

Can’t afford to invest in property?  Don’t want the burden of a huge mortgage debt, yet envy the rental income that property owners enjoy?  You are not alone. But the good news is that there are alternative way to get exposure to property:

  • Without a huge capital outlay
  • Without having to borrow property loan
  • Earn steady rental income, and
  • Enjoy potential price appreciation

How?

By investing in property stocks and/or real estate investment trusts (REITs). Property stocks are shares issued by firms whose main business is to develop and sell properties, while REITs are firms that own income-generating properties. Rents from these properties are distributed regularly as dividends to shareholders after deducting certain expenses. Not surprisingly, many income-oriented investors find REITs attractive. For the remainder of this blog, I will focus on REITs, which has proven to be a popular class of stocks among investors the world over.

There are three main parties in a REIT arrangement: you (the shareholder or unitholder), the REIT manager and the REIT trustee. Sometimes there is a fourth party, which is the REIT sponsor.

The job of the REIT manager is to acquire and manage a portfolio of properties for rental income.  REITs can own almost any type of properties. The most common ones include: logistic buildings, business parks, data centres, shopping malls, service apartments, commercial buildings like offices or mixed office-cum-retail complexes, hospitals, and nursing homes. 

Good managers are proactive in seeking yield accretive properties and in managing the REIT’s leverage. In addition, good managers seek fair, not over-the-top remunerations.

The trustee is responsible for (a) the safe custody of the REIT’s assets and (b) overseeing the activities of the REIT manager to ensure that the manager complies with the Trust Deed and regulations. To perform this role, the trustee must be independent of the manager.

The REIT sponsor is the party that injects properties into the initial portfolio of the REIT for listing on the stock exchange and may continue to make property injections after listing. The sponsor usually has a sizable equity stake in the REIT.

As an  example, take the case of First REIT, a healthcare REIT listed on the SGX. The REIT is sponsored by PT Lippo Karawachi, a property company listed in Indonesia that also owns a chain of hospitals under the Siloam brand. It owns 33% of First REIT.

The REIT manager is Bowsprit Capital Corporation Limited. The manager oversees a clutch of healthcare-related properties comprising hospitals which are mainly located in Indonesia and three nursing homes in Singapore. Bowsprit has the first-right-of refusal to Lippo Karawachi’s healthcare properties. This means that whenever Lippo Karawachi is selling a healthcare asset, First REIT is offered the right to buy the asset first before it is being offered to the market.

Sponsors provides a REIT with a pipeline of its assets. In addition, the interest of shareholders and sponsor are better aligned when the sponsor owns a significant stake in the REIT. This is also the case if the REIT manager has a meaningful stake in the REIT.

A unique feature of REITs is tax transparency. In Singapore, as in most countries, a REIT must distribute at least 90% of net rental income to shareholders to enjoy tax exempt status granted by the tax authority. This “tax transparency” feature is a huge attraction of REITs as it promotes REITs as a class of high dividend yield stocks.

That’s not all.

REITs also enjoys greater transparency in other aspects. First, because REITs are traded on the stock exchange, REIT managers must comply with exchange rules on corporate governance, accounts reporting, and news alerts. Second, because REITs are traded like stocks, their prices are transparent and up-to-date unlike physical properties which turn over less frequently.

Singapore REITs or “SREITs” have come a long way since CapitaLand Mall Trust was listed on SGX in 2002.  Currently, there are 33 S-REITs, with the top ten having a market value of about S$46 billion.

Top 10 S-REITs 

Top 10.jpg

 

 

 

 

 

 

Source: SGX. Data as at 30 May 2017

Overall, Singapore’s REIT sector has maintained a competitive edge over the REIT sector of Japan, Australia and Hong Kong, with a higher average yield of 6.3% and lower gearing ratios.

To see the importance of dividends as a component of returns, refer to the chart below which shows the price and total returns of the 20 largest S-REITs from 30 September 2011 through 30 May 2017. Total returns include price returns and dividends reinvested.

SGX S_REIT 20.gif

Source: SGX

Excluding dividends, a dollar invested in the index increased to about $1.20 over this 6-year period, giving an average return of 3.15% a year. With dividends reinvested, the same dollar grew to $1.80, implying an average annual return of almost 11%. This difference in returns shows that for high yield assets like REITs, dividends are a powerful source of total returns, and a key reason why REITs are compelling investments.

 

 

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