03 November 2016

REIT on!

Owning a property can be a real pain, especially when you are still servicing a loan. Presuming it's rented out, then comes the pain of maintaining the property and dealing with the rent collection and such. There's also the income reporting and tax deductibles. Seems like quite a bit of work.

But there's an easier alternative of course. Outsource it! Let someone else manage it, and you are effectively engaging them to do it for you. Of course they take a cut, but you still get rental returns. With just one property, there's however no economy of scale. So the overheads involved can be high.

And then we have REITs. Effectively the same thing after all, but with the property manager handling multiple properties, collecting rents, while maintaining the properties. It's diversification.

I'm quite for REITs, particularly as they can serve to generate an income stream. It's not without risks though. There will be times when they raise funds from shareholders to fund some acquisitions. Each time they do so, they could very well be collecting whatever income they paid out!

And then, we now have the Phillip APAC Dividend Leaders REIT ETF. So we can own a slice of multiple REITs even! But I have some doubts if it's worth the while right now.

  • With an estimated yield of 5% dividends, its 0.5% management fee would drive it down to ~4.5% yield. I would expect to get 5-7% yield on typical REITs. So getting below 5% seems like a letdown.
  • Significant chunks of the REITs are non-Singapore based. While that offers country diversification, it comes with a foreign exchange risk.
  • And finally, it is a dividend-weighted ETF. If I understand it right, that means high-yielding REITs dominate. My sense is that a high-yielding REIT is not necessarily a good thing. Examine the local REITs and you can see that those yielding above 7% tends to be the ones whose total returns are huge negatives!

For now, I will keep to buying individual local REITs that are backed by parents with the muscle to provide a pipeline of properties to feed them. Capitaland, Ascendas, Mapletree. There are enough choices.

Reaping property incomes without owning any single property nor servicing any loans. I like.


sheng kang said...

Can I ask what are the local REITs that are backed by parents like Mapletree and such as you have mentioned?

Lizardo said...

Hi sheng kang,

Just to name a few:

Mapletree Industrial Trust
Ascendas REIT
Capita Commercial Trust
Capita Retail China Trust

There are a couple more.

Dividend Knight said...

Hi Lizardo,

REITs is an amalgamation of a typical Singaporean's 2 favourite things in investment - Real estate & Passive income. I like them too. Managed to add some to my portfolio during the recent dip.

Lizardo said...

Dividend Knight,

Hope it's the REIT move, and have fun collecting the dividends.

Financial Journalist said...

Alternatively investors can invest into a leverage bond portfolio. The concept is similar to property investment but not the trouble.

For example, most property investors will pay 40% in cash and 60% in loan. Then rent out the property to receive regular income. When the income is in, first pay the loan interest. The excess money left is your gain.

In a leverage portfolio, investors will pay 40% in cash and borrow the rest using loans. Investors will receive regular bond coupons (similar to rental income. First pay the bank, and the excess is your gain.

Investors do not need to find tenants, they just need to find good bonds. Property price can fall. Bonds will always go back to par value at maturity.

More information can be found here:

Lizardo said...

Financial Journalist,

Sounds fascinating. But you're not explaining the downside with leverage. Bonds can also default to zero. No thanks.

Financial Journalist said...

The risk was explained in the link posted.

Here is the content:

What is the risk to the client?

Advance margin of the bond is 75%. Loan draw is 60%. Buffer for price movement is 15%.
If the bond price drops in value by more than 15%, there could be potential margin call.
=> Investment grade short term bond usually does not fluctuate by more than 10% annually.
=> Invest into a wide number of bonds. If one bond is down, some other bonds could be up. This helps to neutralize the drop in portfolio value.

Advance margin of the bond is based on the rating of the bond. If the bond is being downgrade, advance margin may drop. This could potentially trigger margin call.
=> This could be prevented by buying bonds that are from non-cyclical industry where the earnings are more consistent and predictable.
=> Client can choose to buy into bonds that are rated few notches above BBB-. Hence even if the bond is being downgraded, the advance margin of the bond will remain the same.

Borrowing cost of USD could rise and this will reduce the leverage return of the bond.
=> Client can reduce this risk by switching the USD loan to another currency that has lesser probability of rising interest rate. But that would convert interest rate risk to currency risk.
=> Client could invest 1 or 2 banking stocks into the portfolio. Banking stocks tend to do well when interest rate is rising. Capital gains from banking stocks could offset the rise in the higher borrowing cost.

Every investments come with risk. If there is no risk, investors will only be earning risk free return which is near to zero.

The above mentioned risk is still lower than the risk of buying equity using cash.